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Build out a simple 1 year model to analyze a CDS contract. Contract should reflect: An annual payment from the owner of the CDS contract
Build out a simple 1 year model to analyze a CDS contract. Contract should reflect: An annual payment from the owner of the CDS contract A recovery rate of 60% A yield on the corporate of 4% A 1-year risk free rate of 0% Calculate an implied default rate? What happens to that default rate as: 1. Corporate yield falls to 3%. Why does this make sense? 2. Risk free rate rises to 1%. Why does this make sense? 3. Recovery rate falls to 40%. Why does this make sense? Of these 3 assumptions, what do you think the most prone to estimation error? Why? As an investor seeking to have a proper margin of error, what should you do about this assumption? Build out a simple 1 year model to analyze a CDS contract. Contract should reflect: An annual payment from the owner of the CDS contract A recovery rate of 60% A yield on the corporate of 4% A 1-year risk free rate of 0% Calculate an implied default rate? What happens to that default rate as: 1. Corporate yield falls to 3%. Why does this make sense? 2. Risk free rate rises to 1%. Why does this make sense? 3. Recovery rate falls to 40%. Why does this make sense? Of these 3 assumptions, what do you think the most prone to estimation error? Why? As an investor seeking to have a proper margin of error, what should you do about this assumption
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