Bank A is able to raise funds at Libor.Bank B does so at Libor + 30 bps.Bank A buys a reference credit risky asset returning Libor + 70 bps,and then,A and B contract with each other on a credit swap (CDS)where A buys protection on the reference asset from B for $y$ bps.What range of basis points $y$ would be acceptable to both parties in the contract?

Question

Quizplus · Accepted Answer

For the contract to be acceptable to both parties, Bank A would want to pay less than the 70 bps it earns from the reference asset, and Bank B would want to receive more than the 30 bps it costs them over Libor to raise funds. Therefore, $y$ must be greater than 30 bps but less than 70 bps, making $40 < y < 70$ the correct range.

Bank a Is Able to Raise Funds at Libor yyy BpsWhat Range of Basis Points

Bank a Is Able to Raise Funds at Libor $y$ BpsWhat Range of Basis Points