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FRM Part II · FRM Exam Part II · Derivatives

An investor buys a USD 20 million five-year CDS at a spread of 100 bp. One year later, the market spread for the remaining four-year contract is 160 bp, and the risky annuity (PV01) of the remaining contract is 3.6 per unit of notional. What is the approximate mark-to-market value to the protection buyer?

The protection buyer has a mark-to-market gain of about USD 432,000. The spread widened by 60 bp, and multiplying 0.60 percent by the risky annuity of 3.6 and the USD 20 million notional gives that value, positive because the buyer pays below the market rate.

  1. AUSD 432,000 gainCorrect
  2. BUSD 432,000 loss
  3. CUSD 720,000 gain
  4. DUSD 216,000 gain

Explanation

Value = (new spread - contract spread) x risky annuity x notional = 0.0060 x 3.6 x 20,000,000 = USD 432,000. The buyer pays 100 bp but protection now costs 160 bp, so it is a gain. A loss reverses the sign. USD 720,000 mistakenly uses the 100 bp spread or the wrong difference (0.01 x 3.6 x 20m). USD 216,000 halves the result.

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