1. Please refer to the spreadsheet titled 'Ch18_CDS_Valuation.xIsm'. Assume the following: Recovery rate = 40% Notional = $1,000,000 4 quarters = Dec to March, March to June, June to September and September to December. Zero price = Use the zero prices below Zero price (Term- QTR Structure) 0.997381873 0.994435856 0.991251461 0.987720361 Survival probability QTR Survival Probability 0 100% 1 98% 2 95% 3 91% 4 85% Compute the CDS spread. 2. Given the above probability structure, what is the probability of a default in QTR 3 if not default has earlier? What is the estimated probability a default occurrence in QTR 3 independent of the history?1-year Eurodollar Strip to determine a 1-year Spot Rate . Consider the following quotes on a particular day in January March June Sep Dec 92 88 84 80 . An investor expects to receive $1m in March and wants to invest it for a year. He is concerned that the rates may fall by March and hence the return. Wants to lock in the interest rates earned in the future.March June Sep Dec 92 88 84 80 A: Long 1 March contract (in January) $1m turned to $1.147255m in a year. This is a With a 8% annual return (or 2% quarterly) the investor will guaranteed return because these rates were have $1.02m in June. locked. B: Long 1.02 June contracts (in January) With a 12% annual return (or 3% quarterly) the investor will The risk-free (annual) rate of return is 14.7255%. have $(1.02)(1.03)m = $1.0506m in Sep. This is also the 1 year spot rate. C: Long 1.0506 Sep contracts (in January) With a 16% annual return (or 4% quarterly) the investor will have $(1.02)(1.03)(1.04)m = $1.092624m in Dec. A Eurodollar strip consisting of: D: Long 1.092624 Dec contracts (in January) 1 March, 1.02 June, 1.0506 Sep, and 1.092624 With a 20% annual return (or 5% quarterly) the investor will Dec contracts bought in January guarantees an have $(1.02)(1.03)(1.04)(1.05)m = $1.147255m in March. annual rate of 14.7255%