Consider a Two-Year, Annual Pay CDS Contract, Where Premiums Are

question 8

Multiple Choice

Consider a two-year, annual pay CDS contract, where premiums are paid at the end of the year and if default occurs, it is also assumed to happen at the end of the year (but immediately after the premium payment) . Each year there is a 5% risk-neutral probability of the firm defaulting. In default, recovery is 50% (recovery of par, RP) . Assume that interest rates are zero. The fair price of this CDS is a spread of

• A) 200 bps
• B) 225 bps
• C) 250 bps
• D) 275 bps

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Definitions:

Accumulated Depreciation

The total amount of depreciation expense allocated to an asset since it was put into use.

Fully Depreciated

A condition where a fixed asset has reached the end of its useful life and its book value is reduced to salvage value or zero.

No Gain

A financial situation where a transaction does not result in any profit to the party involved.

Revaluation Model

An accounting method that allows assets to be carried at a revalued amount, reflecting current values rather than historical cost, with adjustments made to the assets' carrying amount on the balance sheet.