Question: 4. A hedge fund bought a CDS contract from AIG to protect its position on Apple bonds. The par value of Apple bonds owned by

4. A hedge fund bought a CDS contract from AIG to protect its position on Apple bonds. The par value of Apple bonds owned by this hedge fund is $ 10 million. The notional amount of the CDS contract is also $10 million. The bonds maturity is five years, coupon is paid quarterly. The CDS contract also has five years maturity, and swap premium is paid quarterly. The swap premium is 1%. The coupon rate of Apple bond is 2%. The day count convention for the Apple bond and the CDS premium is actual/360. Today is January 1, 2016 (these two securities are just issued).

a.What are the cash flows for 2016 if Apple does not default until maturity? (15points)

b.What are the cash flows for 2016 if Apple defaults at September 29, 2016? Assuming physical settlement for the CDScontract. (15points)

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