Deck 25: Credit Derivatives

Question 1

Which of the following is true about a CDS?

A) Restructuring is never a credit event
B) Restructuring is always a credit event
C) Certain types of restructuring qualify as credit events but others do not
D) Sometimes a CDS is defined so that restructuring is a credit event and sometimes it is not

Answer 1

D
Sometimes restructuring is included as a credit event and sometimes it is not.

Question 2

In the Lehman bankruptcy the payoff to people who had bought CDS protection was 91.375% of the notional principal.How was this determined?

A) By calculation of the cheapest-to-deliver bond
B) By an auction process
C) By a calculation agent
D) By Lehman's liquidators

Answer 2

B
An auction process is now used to determine cash payoffs on CDSs in the event of a default.

Question 3

A CDS with a number of reference entities provides for each reference entity a payoff if it defaults.What is a name for this CDS?

A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS

Answer 3

B
This is a portfolio of CDSs and is known as an add-up basket

Question 4

If the CDS spread for a regular 5-year CDS is 120 basis points,what is the CDS spread for a 5-year binary CDS on the same underlying reference entity? Assume a recovery rate of 40%.

A) 48 basis points
B) 72 basis points
C) 200 basis points
D) 300 basis points

Question 5

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

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

Question 6

If a tranche spread is 55 basis points and the fixed coupon is 60 basis points,which of the following happens when a trader buys protection?

A) The trader pays an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
B) The trader pays an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
C) The trader receives an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
D) The trader receives an estimate of the present value of 5 basis points per year and then pays 60 basis points per year

Question 7

In a CDS with a notional principal of $100 million the reference entity defaults.What is the payoff to the buyer of protection when the recovery rate is 30%?

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

Question 8

What is the number of companies underlying the iTraxx index?

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

Question 9

Which of the following describes "base correlation"

A) The most basic correlation measure possible
B) A correlation used to value all tranches
C) The correlation implied from market data
D) The correlation for valuing a tranche with an attachment point of 0%

Question 10

Which of the following is the most popular life for a credit default swap?

A) 1 year
B) 3 years
C) 5 years
D) 10 years

Question 11

Gaussian quadrature is

A) A quadratic spline approximation to a normal distribution
B) A way to approximate an integral of a function of a normally distribute variable as a sum of terms
C) A procedure for speeding up Monte Carlo simulation when credit derivatives are valued
D) An alternative to a look up table to determining values of the cumulative normal distribution

Question 12

Which of the following best describes a total return swap?

A) It exchanges the realized return on an asset, including both income and capital gains/losses, for a return, equal to LIBOR plus a spread on the initial value of the asset
B) It exchanges the promised return on an asset, including both income and capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset
C) It exchanges the realized return on an asset, including income but not capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset
D) It exchanges the promised return on an asset, including income but not capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset

Question 13

What is the number of companies underlying the CDX NA IG index?

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

Question 14

Which of the following is true of a synthetic CDO?

A) It is created from portfolios of bonds
B) It is created from portfolios of CDSs
C) It references a standard portfolio of bonds
D) None of the above

Question 15

If the CDS-bond basis is X minus Y,what are X and Y?

A) X is the CDS spread and Y is the excess of the bond yield over the swap rate
B) X is the excess of the bond yield over the swap rate and Y is the CDS spread
C) X is the CDS spread and Y is the excess of the bond yield over the Treasury rate
D) X is the excess of the bond yield over the Treasury rate and Y is the CDS spread

Question 16

The yield on a company's five-year bonds is 5%.The five year swap rate is 4.5% and the five-year Treasury rate is 4%.What would be closest to your best estimate of the five-year CDS spread

A) 200 basis points
B) 150 basis points
C) 100 basis points
D) 50 basis points

Question 17

A portfolio of ten companies is formed.In a third-to-default swap (Circle one)

A) There is a payoff when the third default on the portfolio happens
B) There is a payoff when the first, second and third companies defaults happen
C) There is a payoff when the third, fourth, fifth…tenth companies defaults happen
D) None of the above

Question 18

For what range of losses is the equity tranche of iTraxx (or CDX NA IG)responsible?

A) 0 to 10%
B) 0 to 7%
C) 0 to 6%
D) 0 to 3%

Question 19

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

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 20

What is the rating of the companies underlying the iTraxx index?

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