In this workout, we are given a five year CDS with the following details.

Notional amount of 10 million coupon basis points per annum of 100 par CDS spread of 245 basis points per annum.

Next coupon days of 92, the day count convention on the premium leg of the CDS is actual 360, and the C-D-S-P-V-O one is 3.8.

The first question we need to answer is what is the upfront cash flow on the CDS on trade date, and is it paid by the buyer or the seller? To work out the upfront cash flow, we need to have a look at the difference between the past spread and the standardized coupon.

If we first work that out in basis points, we've got a past spread of 245 minus the coupon of 100.

So that's a difference of 145 basis points.

We now wanna turn this into a percentage, so we're gonna divide by 100 and then again divide by another hundred because we are gonna be multiplying this 1.45% with the 10 million notional, and then by the pvo one the present value of a basis point of 3.8, and that gives us an upfront cash flow of 551,000.

The second part of this question is who is going to be paying this? Is it gonna be paid by the buyer or by the seller? If we think about it, the buyer will be paying the standardized coupon of 100 when in actual fact they should be paying 2 45.

So to compensate for that, they're gonna make this extra upfront payment, the present value of that difference, and that's gonna be that 551,000.

So to sum up, the buyer pays the upfront cash flow.

As the coupon is less than the past spread, the buyer will need to pay the seller the prison value of the difference.

The next question is, what payment is due on the next premium payment date? If there is no default? To calculate this, we need to take the standardized coupon of 100.

Now bear in mind that's basis points, so I'm gonna divide by 100 to get percent and then buy another 100 because I'm gonna be multiplying that with the notional of 10 million.

Then I need to multiply by the days, which is 92, and we told the day count Convention is actual 360, so I'm gonna divide by 360, and that gives us a premium payment of 25555.6.

We are now given some more information and that is that the reference entity defaults and recovery is determined to be 35%.

We need to figure out what payment will be made on the default leg by the seller if firstly, the CDS is physically settled.

Well, if the CDS is physically settled, what that means is the buyer will deliver the bond to the seller, and in exchange the seller will give them the full notional amount, which is 10 million.

Whereas if the CDS is cash cycled, that means the seller will pay to the buyer of the credit protection the amount that will not be recovered.

And so in this case, it'll be one minus the 35% recovery, and we need to multiply that by the notional amount of 10 million to give us 6.5 million.