Consider now that party A wishes to get covered from a potential loss of the face value Va of an asset in case of a credit event.
Party A decides to purchase today
(to =0)
some protection from party B that lasts until some specified maturity date T
.
To pay for this protection, party A makes a regular stream of payments to party B
.
The size of these payments is a fixed percentage of the face value of the asset being insured and it is based on the yearly contractual spread w1y
,
which represents the percentage used to determine the payments' amount over one year. The payments are made every 3 months until maturity of the contract or until a credit event occurs, whichever occurs first. Assume that the credit event occurs as the first event of a Poisson counting process^2
and hence default time is exponentially distributed with parameter
\lambda
.
Denote the short rate with r
.
The aim is to value the premium leg, i e to write a mathematical expression for this stream of payments taking into account both the appropriate discounting and the probabilities of default events.
Face Value
=Va =35000
pounds
Time
T (months
)=30
Wty
=0.0165

lambda
=0.02820

r=0.0332

Using the values provided for your chosen pack, calculate the premium leg and price the CDS
-
Credit Default swap on a spreadsheet with calculations