Your financial institution has lent €500 million to the State of Italy. Italy already has national debt amounting to more than 110 per cent of its annual GDP, and this concerns you greatly – it might default. The €500 million was lent through the purchase of a bond with a 5 per cent coupon maturing in five years (the reference obligation). 

You have asked credit default swap market participants the spread you would have to pay to receive a payout of par value should Italy default on this reference obligation. Answer:212 basis points.

 Use this information to describe, explain and illustrate how credit default swaps can be used to reduce risk for your firm.