If we buy CDS protection, how do we use the CDS coupon and CDS spread to know if we receive a premium or pay one? Say the CDS spread is 3.2% and the CDS coupon is 4.5%. I think if the CDS coupon is greater than the CDS spread, we receive the coupon. Say the spread were to increase to 3.5%, would this be profit or loss to the protection buyer?
First of all, there isn’t a coupon of 4.5%. I think it’s standardized by ISDA after the Great Recession. 1% for investment grade, and 5% for high yield. The CDS spread is the true cost of protection.
Upfront premium from CDS buyer = (CDS spread - CDS coupon)*duration of the CDS Profit for CDS buyer = changes in CDS spread*duration of the CDS*notional
You can workout the numbers yourself.
^Correct
I just came across this question while doing some more mocks. The question is poorly written in that there isn’t a coupon rate of 4.5% in today’s CDS market, maybe it was written before the standardized it? Moreover, due to the lack of information, you have to use the bond’s duration as proxy for CDS duration. Remember, when calculating CDS upfront premium and p/l, always use the duration of the CDS.