The ABC Bank enters into a credit default swap with XYZ Financial.The notional amount of the swap is $50 million.The 5-year swap is based upon a 5-year loan to LMN Corp.The size of the protection payment is 3% per year.As LMN bankrupts during the time this swap is still valid,XYZ has paid ABC $22.5 million for settlements.What is the recovery ratio on the underlying loan?

Question

Quizplus · Accepted Answer

The total protection payment will be 3% x 5 years x $50 million = $7.5 million. Since XYZ has paid $22.5 million for settlements, the recovery ratio on the underlying loan is $22.5 million / $50 million = 45%. Therefore, the correct answer is B.

The ABC Bank Enters into a Credit Default Swap with XYZ