Lecture 8: credit default swaps: fixed coupon bonds. If correlation between interest rate changes and default is positive, you will tend to have to take some money out of your pocket to pay the cds protection buyer. You will thus charge a higher cds premium. If correlation between interest rate changes and default is negative, you tend to be left over with extra cash after you pay off the cds protection buyer. Thus willing to accept a cds premium that is below the credit spread: higher interest rates imply more expensive refinancing, so might lead to more defaults. But the dominant effect is that in recessions rates tend to go down and defaults tend to go up. Different ways of calculating the basis: cds premium is observable, but there are issues with a bond"s credit spread , main problem with credit spread its definition: Credit spread: ytm of a bond minus ytm of maturity-matched risk-free (zero coupon) government bond.