What is CDS?

CDS (credit default swaps) is like insurance on a bond that pays out only if the borrower defaults on his loan. For example, in the subprime mortgage bonds an investor could buy a CDS for a low tranche on a mortgage bond and pay premiums semiannually. If the mortgage borrowers whose mortgages are held by that bond pay their mortgages as expected, the investor only loses the premiums. However, if the mortgage borrowers default on their mortgages, the investor receives multiples of the premiums, making CDS a safe and often lucrative investment.