FRM Part II · FRM Exam Part II · Credit Derivatives
An investor buys protection on USD 10 million notional of a reference entity at a CDS spread of 200 bps, paid quarterly (accrual 0.25 year). A credit event occurs exactly midway through a quarter, after 1.5 months of the quarter has accrued, and the contract provides for accrued premium payment. Ignoring discounting, what accrued premium does the buyer pay at settlement?
The buyer pays USD 25,000. Annual premium is USD 200,000 (2% of USD 10 million), and 1.5 months of accrual is 1.5/12 of that. A full quarter would be USD 50,000, which overstates the accrued amount.
- AUSD 25,000Correct
- BUSD 50,000
- CUSD 100,000
- DUSD 12,500
Explanation
Annual premium = 10,000,000 x 2% = USD 200,000. Accrued for 1.5 months = 200,000 x 1.5/12 = USD 25,000. USD 50,000 is a full quarter, and USD 12,500 uses only 0.75 months.
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