Question

1. Firm A buys CDS from AIG. The notional amount is 1 million USD. The reference entity is firm B. The swap premium is 3%, payable at the end of each quarter. Suppose firm B defaults on January 31. The current price of firm B’s bond is $200 (out of $1,000 par). The day count convention is act/360.

a. What actions each party needs to do if cash settlement? For cash flows, please write down the numbers.

b. What actions each party needs to do if physical settlement? For cash flows, please write down the numbers.

Answer 1

SOLUTION:-

Given

'B' Bond Current Price = $200

Premium = 3%

national amount = 1 million USD

(a). AIG needs to pay firm A = 0.8 million USD Firm A needs to pay AIG for swap premium of = 3% x i million USD x31/360

= $ 2583.33

(b). Firm A needs to deliver firm B's bonds of a total face value of 1 million USD to AIG pays firm A 1 million USD.

Firm A pays AIG for Swap premium of

= 3% x1 million USD x31/360

= $ 2583.33

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