Hi there, I’m currently in doubt concerning an exercise on Schweser Fixed Income Book (Quiz 38.3, from an old book, might not be available anymore…
Im gonna try reproduce the question here:
Notional = $10million
Cheapest to Deliver bond in the market is a 5-year 5% senior unsecured bond, trading at 40% of par.
The issuer files for bankruptcy 6months after the inception of the swap.
Other data: Credit spread = 4.5%
Duration = 4
The CDS is a 5 year , 5% coupon
The question here asks if the buyer would choose physical or cash settlement.
For the cash option, I arrived at a payoff of 6mi
But I’m having issues in calculating the bond market price…the answer says it’s 4.5mi, but isnt the bond trading at 40% par? Shouldn’t the correct answer be 4mi?
I have the info that the underlying bond’s YTM is 6.5% and that the LIBOR yield curve is flat at 2%, implying a credit spread of 4.5%. The bond is $10mi par value, 6% 10-year senior unsecured bond
So how would I arrive at a market price bond of 4.5mi?.
Question 3 tells you to use figure 1 for the values.
It uses the format and approach as I explained in my first reply.
You can’t work out the % par from the information you are trying to use as that is prior to bancrupcy but q3 tells you to use the information in figure 1 post bancrupcy.
I would suggest always posting questions on here with full question you are looking at as there is often information that is required.
