CDS and Credit Markets

The FE-635 syllabus turns to credit as a traded asset through credit default swaps. A CDS exchanges a premium leg for protection against a defined credit event. The buyer pays the spread while the reference entity survives and receives a loss payment after default, subject to the contract's recovery convention.

The notes connect the CDS price to a survival curve and a recovery assumption. A quoted spread is therefore not a pure probability of default; it also contains funding, liquidity, and risk premia. The premium and protection legs must be discounted consistently and aligned on payment dates.

This is why the risk-engineering workbook keeps instrument conventions explicit rather than hiding them behind a single “credit” input.