The New York Times reported Feb. 17 that there are $45.5 trillion of credit default swaps currently outstanding in the marketplace. For starters, that number is twice the value of the U.S. stock market. As most of us donâ€™t have much of an idea of what these financial instruments are, the following example may help to illustrate:
Letâ€™s say that you are 50 pounds overweight and your company wants to help you get in shape. They tell you that they will pay you $100 a pound at the end of 10 months, $5,000 if you can lose all the weight by then. You accept the challenge, but you want your money now to invest in a treadmill, weights and the added supplements and organic food that you need to achieve the goal. You go to the bank and take out a 10 month loan at 10 percent interest and off you go on your weight loss program. The bank, being less sure that you will actually lose the weight, buys a credit default swap (an insurance policy) for the face value of your loan from a third party â€" Investor A.