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Suppose two firms enter into a 4-year credit default swap on in March 2021. Assume the notional principal is $125 million and the buyer agrees to pay 80 basis points per annum with payments being made quarterly. How much is each quarterly payment for the buyer and how much will the buyer pay after four years of quarterly payments if there is no credit event?

User Disp Hay
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A credit default swap (CDS) is a type of derivative contract that transfers the credit risk of a reference entity from the buyer to the seller. The buyer pays a periodic fee, called the CDS spread, to the seller in exchange for a contingent payment by the seller in case of a credit event, such as default, bankruptcy, or restructuring, of the reference entity.

To calculate the quarterly payment for the buyer, we need to multiply the notional principal by the CDS spread and divide by four, since there are four quarters in a year. In this case, the quarterly payment is:

4125,000,000×0.008​=250,000

This means that the buyer pays $250,000 every quarter to the seller as long as there is no credit event.

To calculate the total payment for the buyer after four years of quarterly payments, we need to multiply the quarterly payment by the number of quarters in four years, which is 16. In this case, the total payment is:

250,000×16=4,000,000

This means that the buyer pays $4 million in total to the seller over four years if there is no credit event.

User Kelvin Tan
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