Question

a.Brief description of the EDS payoff mechanism, when is such contract considered "in the money" and could be exercised?

EDS = Equity Default Swap, I hope this helps

Answer 1

An Equity Default Swap (EDS) is a type of “over the counter” derivative contract. In equity default swaps, one party pays a premium to other party. And if there is default in underlying equity then the entire amount would be paid by the other party to the one who pays the premium.

If there will be default the only the other party will pay the amount. But the one party who is taking protection has to pay the premium.    

We can have equity swaps also for the protection of the equity. In this contract two parties agree to exchange a series of cash flow, in which one party pays variable series which is determined by the equity and the other party pays a variable series determined by the different equity or a rate or he can pay fixed series also.

Equity swap is used to convert the returns from the equity investment into another series of return.

There are 3 types of Equity swaps

1. Receive Equity return.
2. Pay fixed and receives equity return.
3. Pay floating and receives equity returns.