Contracts negotiated in private that will protect debt investors against default risk on a selection of debt securities.
The buying investors will pay the seller of the credit default swap (CDS) at stated increments in exchange for protection should the debt securities default. In that case, the seller of the CDS would pay the buyer.
Credit default swaps do not have to be purchased by investors who actually hold the debt in question. Speculators can purchase CDS in order to effectively bet that an entity will default on its obligations. When that happens, the speculator receives the payout from the CDS. This is called a “naked” CDS as the purchaser doesn’t own the debt security that the CDS is insuring them against.