Showing posts with label CDS. Show all posts
Showing posts with label CDS. Show all posts

Wednesday, February 25, 2015

How can CDS prices be above 10,000?

The reason for the question is that CDS prices are in basis points, so 10,000 basis points is 100%. CDS's insure the holder against a default on the underlying security - in Greece's case a sovereign bond. So shouldn't 10,000 basis points be the ceiling - you can't lose more than 100%, right?

No, the time until default matters too. A CDS price of 10,000 makes sense if one knows that an entity will default in 1 year and that there will be no recovery. If one knows that Greece will default on CDS in 1 month's time with no recovery, then the spread would be 120,000 basis points per year. However, the spread would only be collected for one month. So one still earns (120,000/12=) 10,000 basis points.