Question 1

Suppose that an investor has purchased $250 million of protection on the iTraxx Europe which is an equally-weighted index composed of 125 European investment-grade names.If one of the names in the index were to default,the protection seller compensates the buyer for the loss-given-default on that name on a notional of _________________,the index continue to trade on _______________ names;and all subsequent premium payments are based on a notional of______________.

Accepted Answer

A)  1 million;125;250 million
B)  2 million;125;248 million
C)  2 million;124;250 milliion
D)  2 million;124;248 million D

Question 2

A credit-sensitive note (CSN)has a coupon that is indexed to the credit rating of the issuer.When the credit rating worsens,CSNs pay a higher rate of interest and when the rating improves they pay a lower rate.Which of the following is the most valid?

Accepted Answer

A)  The risk in these bonds is that they promise to pay a higher coupon when the company's ability to pay is the weakest.
B)  The CSN has more risk for the investor than a fixed-coupon bond of the same issuer because the coupons are volatile.
C)  Issuers of CSNs prefer to issue these bonds when their ratings are high.
D)  CSNs are expensive because they require the issuer to re-rate its bonds more frequently and thereby incur additional costs. A

Question 3

What action is involved in constructing a synthetic CDO?

Accepted Answer

A)  Selling protection via CDS contracts.
B)  Buying protection via CDS conracts.
C)  Selling tranches of other CDOs.
D)  Buying a diversified equity portfolio. A

Question 4

A first Ðto-default (FTD)basket pays off when the first default occurs in the given basket of "names." The spread on a first-to-default basket is:

Accepted Answer

A)  At least the narrowest credit spread of all the names in the basket and at most the widest credit spread of all the names in the basket.
B)  Equal to the average credit spread across all the names in the basket.
C)  At least the widest credit spread of all the names in the basket and at most the sum of the credit spreads across all the names in the basket.
D)  Equal to the widest credit spread of all the names in the basket.

Question 5

Credit risk in bonds involves uncertainty about whether the bond will default (default risk),and uncertainty about the value of the bonds when they default (recovery risk).In order to profit from a view that default risk will worsen,while not taking a view on recovery risk,you would most prefer to

Accepted Answer

A)  Buy a credit default swap (CDS) and sell a digital default swap (DDS) .
B)  Sell a credit default swap (CDS) and buy a digital default swap (DDS) .
C)  Sell a credit default swap (CDS) .
D)  Buy a digital default swap (DDS) .

Question 6

A collateralized default obligation (CDO)is a pool of securities (collateral)whose cash flows are tranched and sold to investors who take different levels of credit loss in the portfolio.Which of the following is the least likely to be seen in a the collateral of a CDO.

Accepted Answer

A)  A portfolio of equities.
B)  A portfolio of bonds.
C)  A portfolio of CDS.
D)  A portfolio of CDOs.

Question 7

Assume that the CDX-iTraxx index has 125 names in it,for a total notional of $100,000,000.If the recovery rate on default of any name is 40%,at least how many names must default for the 3-7% tranche of the CDO to be wiped out?

Accepted Answer

A)  7
B)  8
C)  15
D)  23

Question 8

A settlement squeeze in the credit default swap market is least likely to occur when the CDS contracts are

Accepted Answer

A)  Settled by delivery of the defaulted reference security in exchange for par value in cash.
B)  Settled by delivery of the defaulted reference security in exchange for the initial value of the security (at swap inception) in cash.
C)  Settled by delivery of the defaulted reference security in exchange for a fixed sum of money.
D)  Cash settled.

Question 9

In a typical Credit Linked Note structure,a special-purpose vehicle (SPV)issues notes tied to the credit performance of a reference obligation.Buyers of these notes are protection on the reference obligation and are the risk of the SPV mismanaging the collateral

Accepted Answer

A)  Buying,Taking on
B)  Buying;Not taking on
C)  Selling;Taking on
D)  Selling;Not taking on

Question 10

Suppose an investor wishes to sell protection on $10 million of the CDX Index where the fixed spread is 100 bps.If the current spread on the index is 150 bps,then the investor will receive

Accepted Answer

A)  The risky present value of 150 bps taken over the life of the contract as an upfront payment at inception.
B)  The risky present value of 50 bps taken over the life of the contract as an upfront payment at inception plus a running quarterly premium of $25,000.
C)  The risky present value of 50 bps taken over the life of the contract as an upfront premium at inception plus a running quarterly premium of $100,000.
D)  The risky present value of 50 bps taken over the life of the contract as an upfront payment at inception plus a running quarterly premium of $150,000.

Question 11

The fair price of a CDS contract on a reference bond is equivalent to that of a spread on a floating-rate bond issued by the same entity as the reference bond and that

Accepted Answer

A)  Is trading at par.
B)  Has the same maturity as the CDS.
C)  Has the same seniority as the reference bond underlying the CDS.
D)  Has all three properties listed above.

Question 12

The asset swap spread is

Accepted Answer

A)  The spread of the fixed rate over current Libor in an interest-rate swap.
B)  The spread over Libor on the floating leg of a swap to exchange the return from a commodity for a floating rate.
C)  The spread over Libor on the floating leg of an interest-rate swap combined with a fixed coupon asset,such that the package is at par.
D)  The spread over Libor on the floating leg of an interest-rate swap combined with a credit default swap,such that the package is at zero value.

Question 13

A $100 million CDO has tranches running from loss ranges of: 0-3%,3-7%,7-10%,10-15%,and greater than 15%.The 7-10% tranche may be stated equivalently as

Accepted Answer

A)  A long call on the CDO collateral at strike $10 million and a short call on the CDO collateral at strike $7 million.
B)  A long put on the CDO collateral at strike $10 million and a short put on the CDO collateral at strike $7 million.
C)  The value of the $3 million tranche plus a call spread consisting of a short call on losses at the 7% strike level and a long call at the 10% strike level.
D)  The value of the $3 million tranche minus a call spread consisting of a short call on losses at the 7% strike level and a long call at the 10% strike level.

Question 14

Which of the following is not one of the three "C"s of lending in banking?

Accepted Answer

A)  Character.
B)  Collateral.
C)  Conscientiousness.
D)  Capacity to repay.

Question 15

A first-to-default (FTD)basket option pays off when any one of the companies in a credit basket defaults.The price of the FTD basket decreases when

Accepted Answer

A)  The credit quality of any issuer in the basket declines.
B)  The correlation of default across names in the basket increases.
C)  The correlation of default across names in the basket decreases.
D)  The volatility of credit spreads for names in the basket increases.

Question 16

CDS settlement is not likely to be triggered by which of the following events?

Accepted Answer

A)  A restructuring of the company.
B)  A secondary equity offering by the company.
C)  Failure to make interest payments on bonds of the company.
D)  The company repudiates its debt.

Question 17

Bank A is able to raise funds at Libor.Bank B does so at Libor + 30 bps.Bank A buys a reference credit risky asset returning Libor + 70 bps,and then,A and B contract with each other on a credit swap (CDS)where A buys protection on the reference asset from B for $y$ bps.What range of basis points $y$ would be acceptable to both parties in the contract?

Accepted Answer

A) y<70y < 70y<70 B) 40">y>40y > 40y>40 C) 40

Question 18

The "base" correlation in a CDO is

Accepted Answer

A)  The lowest correlation implied across all the tranches of the CDO.
B)  The correlation required to match the value of the collateral of the CDO.
C)  The average correlation of all implied tranche correlations.
D)  The correlation required to match total losses from the equity tranche to any particular loss tranche.

Question 19

Bank A has a funding cost of $L + 10$ basis points,where $L$ is Libor.Bank B has funding cost of $L + 80$ basis points.There is a reference obligation currently yielding $L + 140$ basis points.In a "Funding Cost Arbitrage," Bank A pays B the total return on the reference obligation in exchange for a payment of $L + x$ basis points by Bank B,where:

Accepted Answer

A)  The value of  xxx Must lie between 10 and 60
B)  The value of  xxx Must lie between 10 and 80
C)  The value of  xxx Must lie between 60 and 140
D)  The value of  xxx Must lie between 80 and 140

Question 20

Which of the following statements is valid?

Accepted Answer

A)  A seller of credit risk is a buyer of credit protection.
B)  A seller of credit risk is an issuer of credit protection.
C)  A buyer of credit risk is a buyer of credit protection.
D)  None of the above.

Exam 29: Credit Derivative Products

A credit-sensitive note (CSN) has a coupon that is indexed to the credit rating of the issuer.When the credit rating worsens,CSNs pay a higher rate of interest and when the rating improves they pay a lower rate.Which of the following is the most valid?

What action is involved in constructing a synthetic CDO?

A first Ðto-default (FTD) basket pays off when the first default occurs in the given basket of "names." The spread on a first-to-default basket is:

Credit risk in bonds involves uncertainty about whether the bond will default (default risk) ,and uncertainty about the value of the bonds when they default (recovery risk) .In order to profit from a view that default risk will worsen,while not taking a view on recovery risk,you would most prefer to

A collateralized default obligation (CDO) is a pool of securities (collateral) whose cash flows are tranched and sold to investors who take different levels of credit loss in the portfolio.Which of the following is the least likely to be seen in a the collateral of a CDO.