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Credit Default Swap

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									                 Credit Default Swap


              premium (say 40 bps)


Protection                                  Protection
  Buyer                                       Seller

             if reference entity defaults
             pays par value of defaulted
             debt




Reference
  Entity
                        Credit Default Swap


                     premium (say 40 bps)


    Protection                                          Protection
      Buyer                                               Seller

                    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


                premium (say 40 bps)
   A                                                B

Protection                                      Protection
  Buyer                                           Seller

              if reference entity defaults
              pays par value of defaulted
              debt

       LIBOR + spread

                  A’s rate with the swap: LIBOR + spread - premium
Reference
  Asset           Risk-free rate: LIBOR

                  Therefore: premium = spread

								
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