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Credit Default Swap

Credit Default Swap. Protection Buyer. Protection Seller. premium (say 40 bps). if reference entity defaults pays par value of defaulted debt. Reference Entity. Credit Default Swap. Protection Buyer. Protection Seller. premium (say 40 bps). if reference entity defaults

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Credit Default Swap

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  1. Credit Default Swap Protection Buyer Protection Seller premium (say 40 bps) if reference entity defaults pays par value of defaulted debt Reference Entity

  2. Credit Default Swap Protection Buyer Protection Seller premium (say 40 bps) if reference entity defaults pays par value of defaulted debt Physical Settlement: protection buyer sells defaulted assets to protection seller for par value. Cash Settlement: counterparties poll market to determine recovery value of defaulted assets; then protection seller pays the difference between par and recovery value to protection buyer

  3. Valuation – Floating Rate Reference Asset Protection Buyer Protection Seller premium (say 40 bps) A B if reference entity defaults pays par value of defaulted debt LIBOR + spread A’s rate with the swap: LIBOR + spread - premium Risk-free rate: LIBOR Therefore: premium = spread Reference Asset

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