FRM Part II · FRM Exam Part II · Credit Derivatives
A bank buys five-year protection on a reference entity through a CDS with a notional of USD 20 million and a quoted spread of 150 basis points per year. Ignoring accrual and day-count details, what is the approximate annual premium the bank pays?
The annual premium is USD 300,000, because the protection buyer pays the CDS spread of 1.50% on the USD 20 million notional each year. Multiplying 20 million by 0.015 gives 300,000, usually paid quarterly in installments.
- AUSD 150,000
- BUSD 300,000Correct
- CUSD 1,500,000
- DUSD 3,000,000
Explanation
Annual premium = notional x spread = 20,000,000 x 0.0150 = USD 300,000. USD 150,000 results from using 75 bp, USD 3,000,000 from using 15%, and USD 1,500,000 from a decimal-place error.
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