This is a contract that allows someone like a fund manager to in effect insure an asset – say a bond – against default.

This may be preferable to selling the bond if it is illiquid and/or difficult to replace later and/or may trigger a tax liability on sale. The fund manager pays a premium to a bank which is non-refundable provided there is no “credit event” that affects the recoverability of the bond’s cash flows. If such an event takes place the bank is obliged to compensate the fund manager (the CDS buyer).