In this workout, we are told that an investor buys a 6.5% corporate bond at par.

They would like to hedge the credit risk and see the following CDS quote from a market maker.

We've got a five year CDS.

The bid is 215 basis points per annum and the offer is 220 basis points per annum.

We then have a series of questions we need to answer.

You might wanna pause the recording now and try answer these questions.

Before we run through the answers together.

The first question we are asked is whether the investor pays or receives the premium leg on the CDS.

The answer to that is that they pay the premium.

The next question helps explain why they pay the premium.

The question is, on the CDS trade, would you say the investor has bought protection or sold protection? And the answer to that is that they have bought protection.

If there is a credit event on the bond, they are protected as they will receive a payment from the CDS, and so that's why they would be paying the premium leg.

The next question is, which price the investor will trade at.

Will they get the 215 basis points per annum or 220 basis points per annum price? The answer to this one is that they will have to pay 220 basis points premium.

The reason for this is that they get the offer price because they are buying the CDS, they will have to pay the offer price that the market maker is willing to sell at.

The final question is about the all in yield.

The investor will receive once they have hedged the credit risk with the CDS, we know the coupon they'll receive on the bond is 6.5%, but they are giving some of that away because they are paying 220 basis points, which is 2.2% on the CDS for that credit protection.

So they all in yield together with the CDS they've bought is going to be 4.3%.