CREDIT DEFAULT SWAP (CDS)
A CDS is a derivative instrument that can protect the holder of corporate or sovereign debt from the event that a company or government defaults on their debt obligations. It works like a basic swap: the buyer of the CDS gives the seller a series of payments. In return, the buyer will get a payoff from the seller in the event that there is a default.
The amount the buyer pays to the seller each year depends on the CDS spread. The spread is a percentage of the nominal amount of the CDS. For example, if you buy protection on £1m, and the spread is 100 basis points, then the buyer has to pay the seller £10,000 each year.
The market is increasingly using a CDS to determine how credit worthy a company or government is, so, a high spread suggests that there is a high risk the company or government could default on their debt. This has happened to Greece, Portugal and Spain in recent weeks.
Beta is a measure of a stock’s volatility and reflects the degree to which its price fluctuates relative to the overall market. It effectively gives investors an idea of how risky a stock is compared to the wider index.
It is measured using regression analysis and is the tendency of a stock’s share price to respond to swings in the market. If a company has a beta value of one, then its share price ought to move in line with the market. A beta value of less than one indicates that the share price is less volatile than the benchmark, while a value greater than one signals a relatively volatile stock.
On the whole, defensive stocks such as utilities and pharmaceutical companies tend to have low beta while highly cyclical stocks are more volatile. For example, United Utilities has a beta value of 0.65 while RBS’s is 1.75. A negative beta shows that the stock inversely follows the market so it generally decreases in value if the market goes up and vice versa.