Deck 23: Credit Derivatives

Question 1

Which of the following happens when default correlation of the companies underlying a CDO increases? choose one)

A) The value of the senior tranche and the equity tranche to the protection buyer both increase.
B) The value of the senior tranche and the equity tranche to the protection buyer both decrease.
C) The value of the senior tranche to the protection buyer decreases and the value of the equity tranche to the protection buyer increases.
D) The value of the senior tranche to the protection buyer increases and the value of the equity tranche to the protection buyer decreases.

Answer 1

D

Question 2

The recovery rate of a bond is normally defined as: choose one)

A) The value of the bond immediately after default as a per cent of its face value
B) The value of the bond immediately after default as a per cent of the sum of the bond's face value and accrued interest
C) The amount finally realised by a bondholder as a per cent of face value
D) The amount finally realised by a bondholder as a per cent of the sum of the bond's face value and accrued interest

Answer 2

A

Question 3

Which of the following is true? choose one)

A) Risk-neutral default probabilities are usually much lower than real-world default probabilities.
B) Risk-neutral default probabilities are usually much higher than real-world default probabilities
C) Risk-neutral and real-world probabilities must be close to each other if there are to be no arbitrage opportunities default.
D) Risk-neutral default probabilities cannot be calculated from CDS spreads.

Answer 3

B

Question 4

In a one-year forward contract on a CDS that will last five years, what happens if there is a default during the first year? choose one)

A) There is a payoff to the forward protection buyer at the time of default
B) There is a payoff to the forward protection buyer at the end of one year
C) There is a payoff to the forward protection buyer at the end of six years
D) The contract ceases to exist

Question 5

The companies underlying the iTraxx index are: choose one)

A) Rated A or above
B) Rated BBB or above
C) Rated BB or below
D) Rated BBB or below

Question 6

Suppose that the cumulative default probability for a company for years one, two, three and four are 3%, 6.5%, 10% and 14.5% respectively.
i) What is the unconditional default probability for year four? _ _ _ _ _
ii) What is the default probability for year four conditional on no default in earlier years? _ _ _ _ _ _ _ _

Question 7

Which of the following is not true? choose one)

A) There is a payoff when the nth default occurs in an nth-to-default CDS.
B) An add-up basket CDS provides a payoff when any of the reference entities defaults.
C) The CDS spread on a first-to-default swap decreases as the default correlation between the reference entities in the basket declines.
D) The payer in a total return swap suffers a loss if the receiver defaults when the reference bond's yield has increased.

Question 8

The number of companies underlying the CDX NA IG index is: choose one)

A) 50
B) 75
C) 100
D) 125

Question 9

a CDO created from CDSs is known as a _ _ _ _ _ _ CDO.

Question 10

In a CDS with a notional principal of $100 million the reference entity defaults. The payoff to the buyer of protection when the recovery rate is 30% is: choose one)

A) $100 million
B) $30 million
C) $130 million
D) $70 million