CDS Valuation Mathematics
The basic valuation principal in credit derivatives: NPV = Expected Present Value of Cash Flows
"Expected" means "probability-weighted"
"Present value" means "cash flows discounted by the risk-free curve"
Credit instruments have cash flows in:
1.
survival (premiums, coupons, principal, etc …)
2.
default (recovery)
The NPV calculation weighs both survival and default cash flows by the corresponding probabilities and the risk-free discount factors
33