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GARP.FRM.PQ.P2 2016 GARP PQ - Question 5 - CDS (garp16-p2-5)

David Harper CFA FRM

David Harper CFA FRM
Staff member
HI @RushilChulani From the perspective of today, each year's future spread payment, S, will either be made or not (by the protection buyer). The probability it will be made is (1-PD)^n and the probability it will not is 1 - (1-PD)^n where these two probabilities add to 1005, such that the expected future (FV not PV) payment is a weighted average of these two outcomes: S*(1-PD)^n + zero*[1 - (1-PD)^n] = S*(1-PD)^n. I would remind you that, if default occurs it occurs only once on one of the years (e.g., either year 1 or year 2), default cannot occur on both year 1 and year 2. However, survival can occur on all five years. I hope that helps!