HW2 - Columbia University M.S in Financial Engineering IEOR...

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Columbia University M.S. in Financial Engineering IEOR 4731: Credit Derivatives Instructor: Rama CONT Assignment 2: Credit default swaps Assigments should be done individually. The table below displays the CDS term structure for FIAT on July 1, 2004. Maturity (yr) FIAT CDS premium (bps) Treasury yield 1 230 400 3 345 420 5 390 450 7 400 480 10 413 500 Yields are continuously compounded. We shall assume that ± the recovery rate is independent from the default time ± the CDS premium payments are made annually. 1. Using a linear interpolation of the CDS and yield curves and assuming an expected recovery rate R = 40%, construct the term structure of risk-neutral default probabilities F ( T ) for FIAT at maturities T = 1 ; 2 ; 3 ;:: 10 years. 2. Consider a FIAT bond with maturity 5 years, issued on July 1, 2004 for nominal 10 M\$, paying an annual coupon of 8%. Assuming that in case of default the recovery is paid at the ±rst coupon date after default, compute the value of the bond. 3. Repeat questions 1 and 2 assuming an expected recovery rate

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HW2 - Columbia University M.S in Financial Engineering IEOR...

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