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Assume that bank XYZ enters into a credit default swap transaction with bank LMN to hedge its debt exposure with firm C. Bank LMN would
Assume that bank XYZ enters into a credit default swap transaction with bank LMN to hedge its debt exposure with firm C. Bank LMN would fully compensate bank XYZ if firm C defaults in exchange for a premium. Assume that the defaults of bank XYZ, LMN and firm C are independent and that their default probabilities are 0.2%, 0.3% and 3.85% respectively. Estimate the probability that bank XYZ will suffer a credit loss in its exposure to firm C.
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