Question

# 20 A portfolio manager purchased \$4.5MM of credit default swap protection for International Co. with a...

20

A portfolio manager purchased \$4.5MM of credit default swap protection for International Co. with a maturity of 5 years. International Co’s credit spread was 380 basis points when initially purchased but it widened to 520 basis points at the end of the first year. Give the rough calculation of the profit for the portfolio manager (ignoring the time value of money).

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\$252,000

\$170,000

\$420,000

\$555,000

A CDS or Credit default swap is an instrument that gives the right to the buyer of the instrument to recover the loss or compensation from the seller in case of default from the third party.

= Change in CDS Basis point=> (520-380) basis point = 140 basis point=>1.4% (100 basis point is 1%)

N= Notional amount = \$4.5 million= \$4500000

T= remaining time=4 years

hence

Profit for the portfolio manager = 1.4%*\$4500000*4 year = \$252000

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