Question #1
Reading: Reading 29 Credit Default Swaps
PDF File: Reading 29 Credit Default Swaps.pdf
Page: 1
Status: Correct
Correct Answer: B
Question
Gill Westmore is the fixed income portfolio manager for Allied Insurance. Westmore has bought protection using a 2-year CDS on CDX-IG (125 constituent) index. The notional is $200 million. Company X, an index constituent defaults and trades at 25% of par. The payoff on the CDS on account of default of X and the notional principal of the CDS after default are closest to: Payoff Notional
Answer Choices:
A. $1.5 million $198 million
B. $1.6 million $200 million
C. $1.2 million $198.4 million
Explanation
Notional principal attributable to bonds of company X = $200 million/125 = $1.6
million.
Payoff on the CDS = $1.6 million − (0.25)($1.6 million) = $1.2 million.
After default, the CDS continues with (200-1.6) $198.4 million of notional principal.