An FTD is traded on small baskets of about five names1. Its spread is at least the largest CDS spread in the basket and at most the sum of the CDS spreads of all names2. The higher the default correlation, the closer the spread moves to that of the largest single name.

Consider a hypothetical example in which a five-name basket has CDS spreads ranging from 100 to 450bp. The FTD spread is at least 450bp and at most 1,200bp, the sum of the individual spreads. The buyer is compensated only for the first default, and losses on the second and later defaults are not compensated.

Notes

  1. Michael S. Gibson, "Understanding the Risk of Synthetic CDOs" (Federal Reserve Board, FEDS 2004-36, 2004), section 6.2 (page 21). ↩

  2. Joro, Na and Niu (Proceedings of the 2004 Winter Simulation Conference), section 3 (page 2). ↩