Question #4
Reading: Reading 29 Credit Default Swaps
PDF File: Reading 29 Credit Default Swaps.pdf
Page: 2
Status: Incorrect
Correct Answer: A
Your Answer: A
Question
-year, 5% Zillon Corp. bonds currently trade at $980 reflecting credit spread of 3%. A 5-year CDS for Zillon bonds has a coupon rate of 5%. The duration of the CDS = 4. The upfront payment made/received by the protection buyer on a $4 million notional CDS is closest to:
Answer Choices:
A. $400,000 received by the protection buyer
B. $320,000 received by the protection buyer
C. $300,000 paid by the protection buyer
Explanation
Upfront payment
= (CDS spread − CDS coupon) × duration × notional principal
= (0.03 − 0.05) × 4 × 4,000,000 = −$320,000
The protection buyer will receive an upfront premium of $320,000.