Can you explain Credit Default Swaps?

How would you short a private company with credit default swaps?

• I heard Bill Ackman saying a while back that if Herbalife were to privatize, he would simply short the company through other avenues such as through credit default swaps. I understand the basics of CDS securities, but I thought they only secured the principal on default and you had to pay a portion of your received interest to the CDS provider in exchange for the security. So if you are only going to get your initial principal back if the company in question defaults, how are you going to make money, above and beyond your principal with CDS securities?

• Answer:

  Only if somebody wants to take the long end for you. The challenge with the private companies is that not many banks or finance companies will have any opinion about their health . That is why CDS is easier for more public listed companies or their subsidiaries.