Risk measurement on credit default swaps is analogous to risk on bonds and interest rate swaps with CDS, the DVO one or delta measure, which tells us the change in PV of the CDS or the cash p and l on our position for a unit change in the market tends to be called CS O one or spread DV oh one.

So for example, if we were the buyer of a CDs and had a CS O one of $25,000 and the market spread increased by 10 basis points, we would make a profit of $250,000.

You will notice from the graph that the CSO one is a function of the coupon, so the risk is impacted by the choice of standard coupon on a cleared swap.

To understand this sensitivity to coupon, imagine two swaps, one with an annual coupon payment of $100,000 per year and another of 500,000 per year.

The present value of each swap is calculated based on the size of these cash flows and how long they are likely to last.

If we now imagine that the past CDS spread in the market increases, which implies default probabilities go up, this will effectively shorten the expected maturity of the swap.

Since default during its lifetime has now become more likely on the high coupon swap.

This shortening of expected life will have a bigger effect simply because the cash reduction on the premium leg will be larger.

Hence, we see a higher CS O one for the higher coupon swap.

We can of course, scale our position up or down in notional size until we have the desired risk level for a given coupon choice.

Another thing to note is that you can just about see that the line on the graph is not straight, meaning cdss are convex instruments just like bonds and interest rate swaps, and it is the seller who has the positive convexity for those who are interested.

This convexity here is being driven by the changing expected life of the CDS.

As the spread moves up or down, a short position makes money as the CDS spread moves lower, which itself implies a longer expected life.

So when you make money, it is for longer.

The opposite applies if CDS spreads go up.