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Consider the following information regarding a credit default swap that you want to buy. ...

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Finance

Consider the following information regarding a credit default swap that you want to buy.

The default swap offers three years of coverage with the possible default occurring at the end of year one, year two or year three. The face value of the bond to bond to be covered is $1,000,000. The recovery rate for such bonds is 35%. The probability of default in any given year is 5%. The STRIP rates for one, two and three years are 1%, 2% and 3% respectively. How much would you pay for this credit default swap?

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