1. An investor holds a portfolio of $10M of risky bonds on each of the following three companies.
Assume we know the recovery rate for each bond in advance.
a) Firm A with a recovery rate of 40%
b) Firm B with a recovery rate of 30%
c) Firm C with a recovery rate of 50%
2. If the investor uses CDS to protect the $30M 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 $5M first-loss limit
v) Firm A defaults in a senior basket with a $5M first-loss limit