FRM Part II · FRM Exam Part II · Credit Derivatives
A CDS with USD 10 million notional is cash settled after a credit event. The final auction price of the cheapest-to-deliver bond is 35% of par. What does the protection seller pay the buyer?
The seller pays USD 6.5 million. Cash settlement pays notional times one minus the auction recovery price: 10 million times 65% equals 6.5 million. The 3.5 million figure is the recovery value of the bond, not the protection payment.
- AUSD 3.5 million
- BUSD 6.5 millionCorrect
- CUSD 10 million
- DUSD 13.5 million
Explanation
Payout = notional x (1 - recovery) = 10 million x (1 - 0.35) = USD 6.5 million. USD 3.5 million is the recovery value, which the buyer retains by holding the bond, not the payout.
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