In a CDS, which party bears the credit risk of the reference entity?

A. Protection buyer.
B. Protection seller.
C. The third party that issues the debt.

Correct Answer: B

The buyer of a CDS receives credit protection, whereas the seller guarantees the creditworthiness of the reference entity (e.g., the debt of a third party). In doing so, the risk of default is transferred to the seller. For example, the buyer will be entitled to the par value of the contract by the seller of the swap, should the third party default on payments. By purchasing a swap, the buyer is transferring the risk that a debt security will default.