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Credit Default Swap. Protection Buyer. Protection Seller. premium (say 40 bps). if reference entity defaults pays par value of defaulted debt. Reference Entity. Credit Default Swap. Protection Buyer. Protection Seller. premium (say 40 bps). if reference entity defaults

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Credit Default Swap


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credit default swap
Credit Default Swap

Protection

Buyer

Protection

Seller

premium (say 40 bps)

if reference entity defaults

pays par value of defaulted

debt

Reference

Entity

credit default swap1
Credit Default Swap

Protection

Buyer

Protection

Seller

premium (say 40 bps)

if reference entity defaults

pays par value of defaulted

debt

Physical Settlement: protection buyer sells defaulted assets to protection seller

for par value.

Cash Settlement: counterparties poll market to determine recovery value of

defaulted assets; then protection seller pays the difference between par and

recovery value to protection buyer

valuation floating rate reference asset
Valuation – Floating Rate Reference Asset

Protection

Buyer

Protection

Seller

premium (say 40 bps)

A

B

if reference entity defaults

pays par value of defaulted

debt

LIBOR + spread

A’s rate with the swap: LIBOR + spread - premium

Risk-free rate: LIBOR

Therefore: premium = spread

Reference

Asset