Unlike standard credit default swaps which require a valuation following a credit event (usually default), fixed-recovery credit default swaps (CDS) simply specify payment of a fixed dollar payoff. The payoff amount is determined at the contract time, taking into account the severity of the default event. In the vanilla credit default swap, the payoff is equal to the notional principal of the swap minus the post-default value of the insured assets. Therefore, the payoff in a fixed-recovery CDS is stipulated in the contract, rather than left to be determined following the default. A fixed-recovery CDS can be used by investors seeking to enhance the yield on their portfolios. As the implied fixed recovery rate is typically below market rates, the protection seller will receive a higher premium than that associated with a vanilla CDS.
This swap is also known as a digital credit default swap or a binary credit default swap.
