Case Study Of Hypothetical CDS

1624 Words 7 Pages
Hypothetical CDS. According to theory highlighted above, usage of derivatives theoretically should reduce bid-ask spread in NPL portfolio market. In order to examine this theory, hypothetical CDS was priced using real-world data for both CO date and most recent 2017 date. CDS form is selected following Italian securitization law where CDS was used as the guarantee. However, a single-name derivative is priced (versus basket CDS applied in Italian securitization law). As an underlying asset of hypothetical CDS Target portfolio is selected. The price of CDS is then compared with a real CDS market data.
As the creation of hypothetical CDS is a very complex process, the standard model (Hull & White, 2000) used as the basis with applying slightly different assumptions
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The probability of default taken from historical S&P Global rating data (Appendix F) matching BBB rating (matching target portfolio rating of BBB Fitch with S&P rating scale; see Appendix F): period 1- 0.18%, 2- 0.51% and etc. The probability of survival calculated: 1- the probability of default (Banks et al., 2007, p. 171) to every period; period 1: 1 – 0.18%, period 2: 1-0.51%. Fixed payment set semiannual (in aligning with coupon used) diving spread by 2. The expected value of the premium is calculated multiplying survival probability by fixed payment. Following, Present value of premium calculated: Discount factor * Expected value of premium * Open principal (period 1: 0.995* 122. 74*10.7M). Sum of PV of premium =1.184.875€. In addition, PV of accrued interest discounted by the same approach as PV of premium: Accrued interest amount * Discount factor* Open Principal (period 1: 0,995* 0, 11*10.7M). The accrued interest amount is assumed to be half of the fixed payment amount, holding that credit event will occur in the middle of the period (see the formula in page 28): period 1: 122.74/2*0.18. The total amount of Premium leg is defined as a sum of PV of premium and PV of accrued

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