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Fixed Income > Credit Default Swaps > Flashcards

Credit Default Swaps Flashcards

1
Q

(In regards to CDS) Short position of underlying

A

Deteriorating credit quality - Buyer of CDS

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2
Q

(In regards to CDS) Long position of underlying

A

Improving Credit quality - Short CDS

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3
Q

Seller of CDS

A

Improving credit quality - Long underlying

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4
Q

Buyer of CDS

A

Worsening credit quality - Short underlying

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5
Q

CDS Buyer

A

Short Position of underlying credit quality

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6
Q

CDS Seller

A

Long Position

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7
Q

What does the credit protection buyer do in CDS?

A

Premium leg of the CDS
Makes a series of payments (premiums) in exchange.

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8
Q

What does the Credit protection seller do in CDS

A

Protection leg of CDS
Makes payment in the event of credit event

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9
Q

Singel name CDS

A

A CDS on a specific borrower (Reference entity)

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10
Q

Name the 3 different types of CDS

A
  1. Single name
  2. Index
  3. Tranche
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11
Q

What is Physical Settlement of a CDS?

A

Holder of the bond sells to CDS seller at par

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12
Q

What is Cash Settlement of a CDS?

A

Seller pays holder for losses

Swap seller -> Swap buyer
Par - Market value

Payout amount = Payout ratio x Notional amount

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13
Q

CDS leg: Protection Leg

A

Seller pays buyer
Protection seller pays protection buyer if credit event occurs

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14
Q

CDS leg: Premium Leg

A

Buyer pays seller
Protection buyer makes periodic payment to seller of protection

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15
Q

What is the formula for upfront payment

A

PV Protection leg - PV of Premium leg

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16
Q

PV Protection leg > PV of Premium leg

A

> 0

Protection Buyer pays seller

17
Q

PV Protection leg < PV of Premium leg

A

Protection seller pays Buyer

18
Q

Full formula for uprfont payment

A

PV Protection - PV premimum
(Spread - rate) x Duration
(Credit Spread - Fixed Coupon) x Duration

19
Q

Formula for Credit Spread

A

Upfront payment / Duration) + Fixed Coupon rate

20
Q

Formula for Profit for CDS Buyer

A

Change in Basis points x Duration x Notional amount

21
Q

% Change in CDS price

(Formula for Profit for CDS Buyer)

A

Change in basis points x Duration

22
Q

How is the payoff determine for CDS?

A

The cheapest to delivery

Regardless of TTM, always chose the bond with the lowest % value trading at par

23
Q

When credit quality of the reference rate improves, what will happen to the protection leg of a CDS

A

Protection leg gains value, since the credit spread will be less than the premium rate

24
Q

When credit quality of the reference rate deteriorates, what will happen

A

Premium leg gails value, the credit spread will be greater than the premium rate

25
Q

Rates for investment-grade company CDS rates

A

1%

26
Q

Rates for High-yield company CDS rates

A

5%

27
Q

What is Credit spread?

A

Credit spread is the difference between the yield (return) of two different debt instruments with the same maturity but different credit ratings.

28
Q

Name the 3 types of credit event

A
  1. Bankrupcy
  2. Failure to pay
  3. Restrucutring (voluntary restructuring is not a credit event)
29
Q

in CDS
Who will pay if

Credit Spread < Standard Rate

A

Seller (premium leg) pays Buyer (Protection Leg)

30
Q

in CDS
Who will pay if

Credit Spread > Standard Rate

A

Buyer (Protection Leg) pays Seller (premium leg)

31
Q

What is the Recovery rate when CTD (Cheapest to deliver) is 45%

A

The recover rate will then be 45%

32
Q

How to calculate payment of CDS?

A

Use your calculator
N = Number of years
PV = -CVA (negative value)
YTM = MRR
FV = 0

Solve for PMT

33
Q

What does it mean when a CDS is trading at par?

A

It means there is no upfront payment.

PV Potection leg = Pv Premium leg

34
Q

If a HY CDS is trading at par, and the spread is 4.3 %.

What option of trade would be sutible and why?

A

We belive that the rates will eventually converge.

From the perspective of the CDS, its premium is too high relative to the bond credit risk preimum.

From the perspective of the bond, the premium is too love relative to the CDS market, which means its price is too high.

Sell the bond at a profit if the spread goes from 4.3% to 5%.

Sell the protection via the CDS and profit id the spread decreases from 5% to 4.3%

35
Q

Profit for Seller of protection formula

A

-(Change in spread) x Duration x Notional amount

36
Q

If a HY CDS is trading at par, and the spread is 6.3 %.
The CDS is currently 20 BSP above par.

What option of trade would be sutible and why?

A

CDS trading at par means there is no upfront payment. Since the rates are equal to each other.

HY CDS is 5%, a CDS trading at par, plus 20 BSP implies the credit spread on the CDS is 5.2%

We beleive the rates will converge.

From the perspective of the CDS, the premium is too low relative to the bond credit risk premium.

From the perspective of the bondholder, the premium is too high relative to the CDS market, which means the price is too low.

Therefore we would buy the bond and profit from the spead, a decrease from 6,2% to 5.2% and we would buy the CFS and profit from the spread increase from 5.2% to 6.3%

Fixed Income (6 decks)

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