Credit Default Swap Protection Buyer premium (say 40 bps) Protection

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Presentation transcript:

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

Credit Default Swap Protection Buyer premium (say 40 bps) Protection Seller 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

Valuation – Floating Rate Reference Asset Protection Buyer premium (say 40 bps) Protection Seller 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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