What describes a basic credit default swap (CDS)?

A basic credit default swap (CDS) functions as a financial derivative contract that allows one party to transfer the risk of default on a specific asset, usually a bond or loan, to another party. This contract comes into play when a defined credit event occurs, such as default, bankruptcy, or restructuring of the referenced asset.

In this context, the correct understanding is that a CDS references a specific asset. The buyer of the swap pays periodic premiums to the seller and, in return, receives a payment if the specified credit event occurs for that asset. This mechanism highlights how a CDS acts as a hedge against the credit risk associated with that specific entity or asset.

In contrast, the other options describe concepts that are not aligned with the basic structure of a CDS. For instance, referencing a credit index or a portfolio of assets introduces complexities associated with credit index swaps or collateralized debt obligations, rather than a straightforward CDS. Additionally, guaranteeing payment following multiple defaults pertains more to risk management strategies across a portfolio rather than the single asset focus characteristic of a basic CDS.