Today, investor A buys protection on a first-to-default basket, while investor B buys protection via Credit Default Swaps on each individual name in that basket. All contracts have the same maturity. Suppose that at maturity, it turns out that only one name out of the basket has defaulted then,

Question

Quizplus · Accepted Answer

Investor A bought protection on a first-to-default basket, so as long as one name in the basket defaults, they receive the payout. In this scenario, only one name has defaulted, so investor A will receive the payout. Investor B, however, bought protection on each individual name in the basket, so they would only receive a payout if the specific name they bought protection on defaulted. Therefore, Investor A's strategy has been at least as profitable as that of investor B. The spread of the defaulted name is irrelevant in this scenario.

Today, Investor a Buys Protection on a First-To-Default Basket, While