payoff to the market maker in a swap

[ajsa]

Hi David,

"-Max(F - S,0) + Max[Min(S,V)- F,0]"

I wonder if the 2nd part of this formula should be Max[Min(V, S - F),0] instead? If the risky counterparty defaults in this swap, is its liability S-F or S?

Thanks.

 

[David Harper CFA FRM]

Hi asja,

Yes, I thought the same thing(!): http://forum.bionicturtle.com/viewreply/3604/
do great minds think alike or what ?
a little test here: http://sheet.zoho.com/public/btzoho/stulz-vulnerable-swap-v1-1

David

 

[ajsa]

Hi David,

So swap = -put + vulnerable call in that case.

Which formula should we use in exam? Stulz's or ours?

thanks.

 

[David Harper CFA FRM]

Hi asja

I'd use ours b/c his doesn't seem logical (and i think three of us have noticed this, so it's an emerging consensus)...but it's not like GARP keeps a formula list, I wish they focused on these details but i don't think they do...David