A basket default swap which sets a maximum payout for each defaulted reference entity and a maximum aggregate payout over the term of the swap for the basket of reference entities. For example, if a subordinate basket default swap, consisting of three entities, stipulates that defaults result in losses for the three entities (from the first to the third) in the tunes of 3, 5, and 8 million US dollars, respectively.
Assuming that the maximum payout for an individual entity is $5 million, and that the maximum total payout is $7 million. A default by the first entity triggers a payout of $3 million. The remaining amount that is available for payment on any subsequent defaults for the other two reference entities is $4 million (7-3= 4). In case the second entity defaults, only $4 million will be paid out, rather than $5 million. At this point, the swap terminates.
Comments