22-80 XYZ Bank lends $20,000,000 to ABC Corporation which has a credit rating of BB.The spread of a BB rated benchmark bond is 2.5 percent over the U.S.Treasury bond of similar maturity.XYZ Bank sells a $20,000,000 one-year credit forward contract to IWILL Insurance Company.At maturity,the spread of the benchmark bond against the Treasury bond is 2.1 percent,and the benchmark bond has a modified duration of 4 years.What is the amount of payment paid by whom to whom at the maturity of the credit forward contract?

Question

Quizplus · Accepted Answer

To calculate the payment under a credit forward contract, we need to determine the difference between the actual spread at maturity and the contracted spread, and multiply it by the notional amount of the contract ($20,000,000).

The contracted spread is given as 2.5%, and the actual spread at maturity is 2.1%. Therefore, the difference is 0.4%. Multiplying this by $20,000,000 gives us the payment amount of $80,000.

However, since the contract is sold by XYZ Bank to IWILL Insurance Company, the payment is made by the seller (XYZ Bank) to the buyer (IWILL Insurance Company). Therefore, the correct answer is A) The seller pays the buyer $320,000 (4 times $80,000).

22-80 XYZ Bank Lends $20,000,000 to ABC Corporation Which Has