Question

The table below shows the bid/ask quotes by UBS for CDS spreads for companies A, B, and C. CSFB has excessive credit exposure to Company C and wants to reduce it through the CDS market.

	1 Year	3 Year	5 Year
A	15/25	21/32	27/36
B	43/60	72/101	112/152
C	71/84	93/113	141/170

Since the farthest maturity of its exposure to C is three years, CSFB buys a USD 150 million three-year protection on C from UBS. In order to make its purchase of this protection cheaper, based on its views on companies A and B, CSFB decides to sell USD 300 million five-year protection on Company A and to sell USD 100 million one-year protection on Company B to UBS. What is the net annual premium payment made by CSFB to UBS in the first year?

1)	USD 1.02 million

2)	USD 0.455 million

3)	USD 0.58 million

4)	USD 0.62 million

Answer 1

CSFB buys a USD 150 million three-year protection on C from UBS

Buying at an ask price of 113 = 150*113 = 16,950

CSFB decides to sell USD 300 million five-year protection on Company A

Selling at the bid price of 27 = 300*27 = 8,100

sell USD 100 million one-year protection on Company B to UBS.

Selling at the bid price of 43 = 100*43 = 4,300

Thus, annual premium paid net of premium received = 16,950 - 8,100 - 4,300 = 4,550

Thus, adjusting for scaling for CDS quotes, answer = 2) USD 0.455 million