In this workout, we see an example of a CDS trade where the underlying credit is improving. So Alpha buys a 2-year CDS from Beta on a notional amount of 100 on the 3-year bonds issued by Charlie. The CDS has an annual premium of 105 basis points. A few days into the contract, Charlie begins to experience unexpectedly favorable trading conditions. So it's good news for Charlie. The CDS spread goes down by 50 basis points. Alpha unwinds the CDS trade. What will be the net cash flows over the CDS term for Alpha? Well, of course, this is a credit improvement here in Charlie, so we expect this to be bad news for Alpha. Let's have a look at the cash flows.

The original trade, it was two years. The premium was the 100 five basis points. The notion was 100, and therefore, of course, the total premium paid out over the period of the contract, the CDS, will be two times the annual premium times the notional. So the premium paid out will be 2.1.

However, seeing that the credit has improved a lot, Alpha immediately closes out the CDS. So they do it immediately. So that means that the duration of remaining here is two years still. The notion will be 100 still, but this case, they go short the CDS. The CDS spread has just improved by 50 basis points. So they now will receive 55 basis points on closing out that CDS. So the total premium that they receive as they close this out will be the two years remaining times the notional times the new CDS spread, which is 55 bps. So they'll receive 1.1 when they close this out. So the net cash flows, of course, is that they received 1.1 when they closed the position out, but they still have to pay the 2.1 in premium. So the net cash flows here are minus one. So this is the loss to Alpha on this position and it happened very, very quickly. So Alpha speculated incorrectly in credit deterioration of Charlie, but what happened was, of course, a credit improvement. So they saw a loss here of minus one immediately.