FRM Part I · FRM Exam Part I · Credit Risk Transfer Mechanisms
A five-year CDS on Firm Z has a notional of $50 million and a quoted spread of 240 basis points per year, paid annually for simplicity. The buyer pays the spread each year. What is the annual premium payment, and who pays it?
The annual premium is $1.20 million, paid by the protection buyer. It equals the 240 basis point spread, 2.40%, multiplied by the $50 million notional. The seller receives this payment in return for agreeing to cover losses if a credit event occurs.
- A$1.20 million paid by the protection buyerCorrect
- B$1.20 million paid by the protection seller
- C$2.40 million paid by the protection buyer
- D$0.12 million paid by the protection buyer
Explanation
Premium = 0.0240 × $50,000,000 = $1,200,000 per year. The protection buyer pays this to the seller. Paying $2.4 million would use 4.8% by mistake, and $0.12 million misplaces the decimal.
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