Credit Default Swap

1
Credit Default Swap
Protection Buyer
Protection Seller
premium (say 40 bps)
if reference entity defaults pays par value of
defaulted debt
Reference Entity
2
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
3
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
As rate with the swap LIBOR spread - premium
Risk-free rate LIBOR Therefore premium
spread
Reference Asset