A swap dealer buys and sells collateralized debt obligations (CDOs), known as credit default swaps (CDS), and must be licensed to sell securities. They negotiate premium payments and commissions based on the level of coverage and risk involved.
A swap dealer is a licensed investment broker who buys and sells collateralized debt obligations (CDOs), known as CDS (credit default swaps). These instruments function similarly to insurance products in that the party purchasing a CDS insures a debt instrument owned by the issuer of the CDS in exchange for regular premium payments. Swap dealers are employed by brokerage firms or investment firms and these individuals may trade on behalf of the issuer or buyer of the CDS.
In many countries, brokers can trade swaps in the same way that other types of securities, such as stocks and bonds, are traded, although swap transactions are often private; this means that transactions take place outside of stock exchanges. However, individuals who trade these trades must be licensed to sell securities. To become a licensed broker, an individual must attend a series of training classes administered by representatives of the regional or national securities regulatory authority. At the end of the training session, participants must successfully pass an exam before they can apply for a license. While a swap trader doesn’t necessarily need to have a college degree, many companies prefer to hire traders who have degrees in finance, economics or a related topic.
CDS issuers use the money raised from selling swaps to fund loans and other investment opportunities. Therefore, a swap dealer employed by the company issuing swaps must aggressively market these instruments to investors. The dealer tries to negotiate the lowest possible premium, proving to potential investors that the insured assets are low-risk securities. If the CDS buyer never needs to make a payment, the issuer premium payments provide the buyer with pure profit. In most cases, purchase contracts include a clause that allows the buyer to increase the premium amount later, and the broker is responsible for negotiating the lowest possible price.
Many large investment firms and venture capital firms buy swaps issued by various types of businesses. These companies employ dealers who try to negotiate high premiums in order to maximize the buyer’s potential profits. Premium prices depend on risk levels and the riskiest swaps typically involve the highest premium payments. A swap trader has to weigh the risks of obtaining the most profitable premium payments, ensuring that the buyer is not exposed to excessively high levels of risk.
Like most investment brokers, a swap trader is usually paid on commission. For dealers who represent swap buyers, commissions are usually linked to swap premium payments. Dealers representing swap issuers typically receive commissions based on the level of coverage the swap buyer is willing to provide. In other cases, brokers receive commissions based on the number of trades executed within a specific time period.
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