1) Calculate the probability pf default and survival

1
2
3

Default
Probability
0.02
0.0196
0.019208

Survival
Probability
0.98
0.9604
0.941192

0.01882384

0.92236816

0.0184473632

0.9039207968

Time (years)

a) PV of swap = PV of survival + PV of default at given probabilities

b) PV of payoff = PV of payoff if default occurs
c) At breakeven, PV of swap = PV of payoff
2) PV of Payment if survive, per $1 of investment
s = annual rate of payment
Time (yrs)
1
2
3
4
5
Total

r=

0.05

Survival Prob Expected Paymt Discount Factor PV of Exp Pmt

0.98
0.9604
0.9412
0.9224
0.9039

0.9800s
0.9604s
0.9412s
0.9224s
0.9039s

0.9512
0.9048
0.8607
0.8187
0.7788

0.9322
0.8690
0.8101
0.7552
0.7040
4.0705
4.07052466461742s

3) PV of Payment if defaults per $1 of investment, assuming payoffs happen every ha

Expected Accr
Time
Default Prob
Disc Factor
PV of Pmt
Pmt
0.9753
0.5
0.02
0.01
0.00975
0.9278
1.5
0.0196
0.0098
0.00909
0.8825
2.5
0.0192
0.0096
0.00847
3.5
0.0188
0.0094
0.8395
0.00789
4.5
0.0184
0.0092
0.7985
0.00735
0.04255
Total
0.0425547211080096s

4) PV of Payoff for $1 of investment if Default Occurs

Time (yrs)
0.5
1.5
2.5
3.5
4.5
Total

Default Probab. Rec. Rate

0.02
0.0196
0.0192
0.0188
0.0184

Breakeven CDS spread

0.4
0.4
0.4
0.4
0.4

Expected Payoff Discount Factor

0.012
0.01176
0.01152
0.01128
0.01104

4.0704s + 0.0426s = 0.0511

4.1330s = 0.0511
s = 0.0124

0.9753
0.9278
0.8825
0.8395
0.7985

Value of swap per $1 of principal = 4.1130s -0.0511

7052466461742s
payoffs happen every half year

0.00975312440139041s

25547211080096s

PV of Exp.
Payoff
0.01170
0.01091
0.01017
0.00947
0.00882
0.05107

r=

Time (years)

Default
Probability

1
2
3
4
5

0.02000
0.01960
0.01921
0.01882
0.01845

0.05

Payment if Survive per s unit of CDS

Survival
Discount Factor PV of Exp Pmt
Probability
0.9800
0.9512
0.9322
0.9604
0.9048
0.8690
0.9412
0.8607
0.8101
0.9224
0.8187
0.7552
0.9039
0.7788
0.7040
4.0705
PV of expected payment 4.07050790690272s

Payment if defaults per s unit of CDS

Expected Accr
Time
Disc Factor
PV of Pmt
Rec. Rate
Pmt
0.01000
0.9753
0.0098
0.5
0.4
0.00980
0.9278
0.0091
1.5
0.4
0.00960
0.8825
0.0085
2.5
0.4
0.00941
0.8395
0.0079
3.5
0.4
0.00922
0.7985
0.0074
4.5
0.4
0.0426
Total
7050790690272s
0.0425871682334675s
Total

Expected Payoff
0.01200
0.01176
0.01152
0.01129
0.01107
NPV

PV of Exp Payof
0.01170
0.01091
0.01017
0.00948
0.00884
0.05110

Value of swap = CDS spread

Risk free rate
Recovery Rate

1
A
Time
(years)

Default
Probability

1
2
3
4
5

0.20000
0.16000
0.12800
0.10240
0.08192

0.05
0.4

2
B

D
BxC
Payment if Survive per s unit of CDS
Survival
PV of Exp
Discount Factor
Probability
Pmt
0.8000
0.9512
0.7610
0.6400
0.9048
0.5791
0.5120
0.8607
0.4407
0.4096
0.8187
0.3354
0.3277
0.7788
0.2552
2.3713

F
A x 0.5
Payment if defaults per s unit of CD
Expected Accr
Time
Pmt
0.10000
0.5
0.08000
1.5
0.06400
2.5
0.05120
3.5
4.5
0.04096

PV of expected payment 2.371341900713s

PV of expected payment

Formula 2.67526270125858 s = 0.36470496

Solve for S
s = breakeven CDS spread
Value of swap per $1 of principal = 4.1130s -0.05

1) Calculate the probability pf default and survival

2) PV of Payment if survive per $1 of investment
3) PV of Payment if defaults per $1 of investment, assuming payoffs happen ev
4) PV of Payoff for $1 of investment if Default Occurs

4
G

H
FxG
if defaults per s unit of CDS
Disc Factor
0.9753
0.9278
0.8825
0.8395
0.7985
Total

I
A x ( 1-R)
GXI
Value of CDS after default
PV of Exp
PV of Pmt Expected Payoff
Payof
0.0975
0.12000
0.11704
0.0742
0.09600
0.08906
0.0565
0.07680
0.06778
0.0430
0.06144
0.05158
0.0327
0.04915
0.03925
0.3039 NPV
0.36470

PV of expected payment 0.303920800545584s

858 s = 0.364704960654701

ven CDS spread

f principal = 4.1130s -0.0511

ssuming payoffs happen every half year

Swap is expected to happen

if the default prob is 100% a

PV Survial BCD
PV of Default

p is expected to happen evey half year

e default prob is 100% a dollar is lost for every dollar spent

value of CDS after deafualt = L(1-R)

R is recovery

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