I have a few questions on CDS and especially sovereign ones:

  1. I've read that usually CDS are generally traded in millions of notional value, which means that not everybody can purchase sovereign CDS, but who will ? Banks, other countries, ... ?
  2. Another thing that is a bit unclear, let's say a CDS is bought at day D with maturity T and at X bps. But at day N when the next premium is due the CDS is at Y bps. This premium is based on X bps or Y bps? (it would make more sense to me that it would be Y bps but I'm not 100% sure)
  3. I've seen many different formulae for the CDS spread and pay-off, are the following formulae accurate?
    • CDS Spread = n-Year Bond Yield – n-Year Risk-free Yield
    • CDS Payoff = Notional Principal × (1 – Recover Rate)
  1. In most cases min. value of CDS trade is 5M USD/EUR. Usually protection buyers are hedgers. A typical profile for protection buyer is a private equity fund, who hedge their credit risk on FI portfolio, sometimes not even for themselves. Protection sellers are financial institutes, but they use CDS to arbitrage credit derivatives market. For example there are some CDS Index instruments like iTraxx, CDX and some others which include protection of X different names. And single names (esp. corporates) priced with correlation to index. It's a simple example, but sometimes value of single names combined worth less, then index price or ..vice versa.

  2. Yes, your logic about Y bps is right. But as I already mentioned above, it's an OTC instrument. So guess how many market participants will sell you CDS on 100% sure default tranches. Or buy protection on AAA-super-senior. (Well it's not pretty accurate, but I guess you already understood my logic) You could check your thesis at IHS Markit it's a data provider on CDS market and see how bid/offer bps prices changes.

  3. The second formula about CDS payoff is correct, but it's a very simple way to evaluate payoff. You should visit http://www.creditfixings.com to make sure what happens with companies which face default procedure and how exactly Recovery is calculated.

  • $\begingroup$ Hi @AlexZeDim thank you very much for your answer! Most of the things are quite clear to me expect your 2nd answer, is it a real yes ? :) Moreover, I have others questions may I ask them here or should I modify/edit my main question? $\endgroup$ – bixoez Oct 6 '18 at 14:15

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