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I do not get the following:
1.Does trading at 50% of par mean that the bond is at default and this is the value the bond holder will recieve at default
2.Why would Deem can cash settle for $6 million [= (1 – 40%) × $10 million] on its CDS, does a $10mm CDS mean that the other party pay the difference between the $10mm and the $4mm?
3.In case of physical settlement, why would Deem deliver the bond, is not he the one that should receive the bond back in order to sell it?
There’s some information missing; for example, the question to which A and B are answer choices.
Apparently UNAB is in default. That information is missing.
The bonds are still being bought and sold on the open market, at 50% of par. If Deem wanted to sell its (defaulted) bonds, it would get $5 million on the open market.
When you settle for cash you keep the bond. If Deem receives $6 million in cash, they still own a bond that they can sell for $5 million, getting $11 million total. If they deliver the bond, they get only $10 million.
That’s what physical settlement means: Deem gives the bond to the CDS issuer, and the CDS issuer gives Deem $10 million.