Credit event is an event that defines default by the reference entity. When a credit event occurs, the protection seller makes a payment to the protection buyer.
Three general types of credit events include:
If credit event has occurred, two parties to a CDS have the right to settle the CDS. Settlement can happen in two ways:
Default does not mean that the creditor will lose the entire amount owed as a portion of the loss could be recovered. The recovery rate is the percentage of the loss recovered. The payout ratio is an estimate of the expected credit loss.
Payout ratio = 1 – recovery rate (%)
Payout amount = Payout ratio * notional amount
Sign up to get more!