How is the standardized CDS upfront payment calculated?

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AcadiFi · Accepted Answer

The upfront payment equalizes the present value of the contract given the market's view of the issuer's credit risk and the fixed coupon level. Protection buyer pays upfront if the market-implied par spread is higher than the fixed coupon; protection seller pays upfront if the par spread is lower. Formula: upfront equals (par spread minus fixed coupon) times risky PV01, approximately. For a 5-year CDS on Castelwood Industrial trading at a 210bp par spread with a 100bp fixed coupon and a risky PV01 of 4.35, the upfront is roughly (210 - 100) x 4.35 / 100 = 4.785 points, meaning the protection buyer pays about $4.785M per $100M notional plus the 100bp running coupon. If the par spread drops to 80bp — meaning credit improved — the upfront becomes negative and the protection seller pays the buyer about $0.87M. The ISDA Standard Model computes this using flat hazard rate calibrated to the par spread, 40% recovery, and the ISDA discount curve. The standardization was introduced to facilitate central clearing: with only two coupon levels (100bp for IG, 500bp for HY), contracts are fungible across counterparties. FRM exam problems often give you a par spread and fixed coupon and ask you to compute the upfront. Memorize the formula and practice with different tenors and spread levels.

How is the standardized CDS upfront payment calculated?

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