Question 1

Total return swaps (TRSs)are sometimes undertaken between banks who can access an asset on-balance-sheet and funds that lack access to,or are not allowed to,hold the asset.In such a situation,

Accepted Answer

A) The bank is using the TRS to enhance its credit exposure to the underlying asset. 
B) The fund is making the bank assume risk that it does not itself wish to assume. 
C) The bank is enhancing its return at the expense of the fund. 
D) The bank is effectively lending the use of its balance sheet to the fund.

Question 2

Which of the following factors contributed to the the substantial growth in the market for credit derivatives in the 2000s?

Accepted Answer

A) Extensive growth in debt markets. 
B) Disintermediation of banks. 
C) Increases in regulation of securities markets,investors,and issuers. 
D) All of the above.

Question 3

A digital default swap is a contract that is distinct from a credit default swap in that

Accepted Answer

A) It pays nothing is no credit event occurs. 
B) It pays a fixed amount if a credit event occurs. 
C) It has a single premium upfront instead of periodic premium payments. 
D) Premium payments are only due if a credit event occurs.

Question 4

Bank A is able to raise funds at Libor + 10 bps.Bank B does so at Libor + 40 bps.Bank A buys a credit risky asset returning Libor + 100 bps,and then A and B enter into a total return swap (TRS)where A pays B the total return on the asset in return for Libor + $y$ bps.What range of basis points $y$ would be acceptable to both parties in the contract?

Accepted Answer

A)  $y  10$ 
C)  $40 < y < 60$ 
D)  $10 < y < 40$

Question 5

Today,investor A buys protection on a first-to-default basket,while investor B buys protection via Credit Default Swaps on each individual name in that basket.All contracts have the same maturity.Suppose that at maturity,it turns out that only one name out of the basket has defaulted then,

Accepted Answer

A) Investor As strategy has been at least as profitable as that of investor B 
B) Investor Bs strategy has been at least as profitable as that of investor A 
C) Both strategies have been equally profitable 
D) The answer depends on the spread of the defaulted name

Question 6

If you are interested in speculating on a deterioration in the credit quality of a company,which of the following would be appropriate?

Accepted Answer

A) Buy the bonds of the company. 
B) Short the forwards on the credit spread of the company. 
C) Buy credit spread call options on the company's bonds (i.e. ,options that pay off if the spread widens). 
D) Sell put options on the company's bonds.

Question 7

Which of the following credit derivatives is not a pure credit risk instrument,i.e. ,is a bet on more than just credit risk?

Accepted Answer

A) Credit spread forwards. 
B) Credit spread options. 
C) Total return swap. 
D) Credit default swap.

Question 8

The CDS-Bond basis is the difference in credit spreads in the CDS and bond markets,i.e. ,CDS spread minus the bond spread.Which of the following scenarios will make the basis greater,i.e. ,move it in the positive direction?

Accepted Answer

A) The bond market becomes illiquid relative to the CDS market. 
B) The demand for convertible bonds increases,as does the need to hedge the credit risk in these bonds. 
C) The market for synthetic CDOs heats up. 
D) The bond price moves down sharply.

Question 9

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 recovery risk will worsen,you would

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

Question 10

Which of the following is not a property or benefit of credit derivatives?

Accepted Answer

A) In instruments subject to multiple sources of risk (such as junk bonds),they enable separating out credit risk from other risks. 
B) They enable hedging out credit risk of securities that are illiquid and hard to sell. 
C) They reduce the overall level of default risk in the economy. 
D) They offer reference prices that make it easier to price other securities that have credit risk.

Question 11

Consider a total return swap (on a credit-risky bond)of total returns against Libor.The receiver of total return in this swap has a position that is equivalent to

Accepted Answer

A) A forward contract to buy the asset at a fixed price at maturity of the swap. 
B) A long position in the asset and short position in a floating-rate note. 
C) A short position in the asset and long position in a floating-rate note. 
D) An asset swap that delivers the asset in exchange for a floating-rate note.

Question 12

Bank A holds a credit risky asset on its balance sheet.It enters into a total return swap (TRS)referenced to this asset with hedge fund B to pay the total return to B and receive Libor in return.Under what scenario does bank A bear credit risk on the reference asset this contract?

Accepted Answer

A) When the issuer of the reference asset defaults. 
B) When hedge fund B defaults. 
C) Only when the issuer of the reference asset and hedge fund B default. 
D) All of the above.

Exam 29: Credit Derivative Products

Total return swaps (TRSs) are sometimes undertaken between banks who can access an asset on-balance-sheet and funds that lack access to,or are not allowed to,hold the asset.In such a situation,