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Pay-as-you-go settlement (PAYG or PAUG settlement)

A form of settlement used in asset-backed credit default swaps which allows two-way payments between the protection buyer and protection seller during the life of the contract. If the reference obligation is affected by interest shortfalls or principal writedowns, the protection buyer compensates the protection seller. These amounts are paid back to the protection buyer if the interest shortfalls or principal writedowns are reversed. The protection buyer has the option of physically settling the credit default swap if there is a principal writedown.