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FRM Part II · FRM Exam Part II · Credit Derivatives

A dealer prices a 5-year CDS on a corporate name with a standardised coupon of 100 bp. The par (market) spread for the name is 160 bp, and the risky annuity (risky PV01) is 4.2 per unit of notional. Ignoring accrued premium details, what is the approximate upfront payment per 10 million notional, and who pays it?

The protection buyer pays about 252,000. The upfront equals the difference between the par spread and the fixed coupon, 60 bp, times the risky annuity of 4.2, giving 2.52% of 10 million. The buyer pays because the 100 bp coupon is below the market spread.

  1. AProtection buyer pays about 252,000Correct
  2. BProtection seller pays about 252,000
  3. CProtection buyer pays about 672,000
  4. DProtection buyer pays about 168,000

Explanation

Upfront ≈ (par spread − coupon) × risky annuity = 0.60% × 4.2 = 2.52% of notional, i.e. 252,000 on 10 million. The buyer pays because the fixed coupon is below the market spread. Using the full 160 bp gives 672,000, which ignores the coupon already being paid.

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