An investor holds a portfolio of $10 million of risky bonds on each of the following three companies. Assume that we know the recovery rate for each bond in advance:
a) Firm A with a recovery rate of 40% à 10 million, LGD = 6 mio
b) Firm B with a recovery rate of 30% à 10 million, LGD= 7 mio
c) Firm C with a recovery rate of 50% à 10 million, LGD = 5 mio
If the investor uses CDS to protect the $30 million investment, how much would the investor receive in each of the following scenarios:
i) Firm B defaults in a standard CDS.
ii) Firm B defaults in a first-to-default basket.
iii) Firm A defaults, followed by firm B in a first-to-default basket.
iv) Firm C defaults in a senior basket with a $5 million first-loss limit.
v) Firm A defaults in a senior basket with a $5 million first-loss limit.