What will happen to a CDS buyer when the bond defaults? I kinda heard of 2 versions: 1) receive PAR and put the bond to the CDS seller 2) receive a pari passu bond and put the defaulted bond to the CDS seller. WHich one is correct? Or both?

I don't think 2) is right, there would be no point - if you receive a pari passu bond it would be just as worthless.The two possibilities I am aware of are physical settlement or cash settlement.In physical settlement you put the reference bond OR a pari passu bond to the seller and get par.In cash settlement you receive cash equal to Par - current MV of defaulted bond. (MV of bond will be non-zero assuming recover rate > 0).Cash settlement is less popular because of the difficulty of getting and agreeing a makret price for a bond that has just defaulted.

QuoteCash settlement is less popular because of the difficulty of getting and agreeing a makret price for a bond that has just defaulted. In addition to markfd's excellent comments I'd like to say that the price of a bond immediately after default is usually much lower than the amount that is actually recovered. Those that write protection are loath to pay the difference between the immediately post default price and par, and not receive an asset that is going to appreciate. That being said those that buy protection do not feel like waiting around 6 months for the price to rebound so that the deal can be settled in cash. What a quandry. So as Mark says, quotes are usually for physical settlement. Depending on how the cash settlement is done (immediately after bk, 6 mos down the road) quotes will be (wider, tighter) than a price that is physically settled.