Chapter 4 Flashcards
If an investor holds a five-year IBM bond, it will give him a return very close to the return of the following position:
a. A five-year IBM credit default swap on which he pays fixed and receives a payment in the event of default
b. A five-year IBM credit default swap on which he receives fixed and makes a payment in the event of default
c. A five-year U.S. Treasury bond plus a five-year IBM credit default swap on which he pays fixed and receives a payment in the event of default
d. A five-year U.S. Treasury bond plus a five-year IBM credit default swap on which he receives fixed and makes a payment in the event of default
d. A five-year U.S. Treasury bond plus a five-year IBM credit default swap on which he receives fixed and makes a payment in the event of default
A credit default swap is an instrument that can be characterized best as:
a. Any swap that has one or more parties in default
b. A swap that can only be valued against non-investment-grade debt securities
c. An option to sell defaulted securities at par value to a third party in exchange for a series of fixed cash flows
d. Any swap that defaults to a third-party guarantor should a party in swap file for bankruptcy protection
c. An option to sell defaulted securities at par value to a third party in exchange for a series of fixed cash flows
A portfolio manager holds a default swap to hedge an AA corporate bond position. If the counterparty of the default swap is acquired by the bond issuer, then the default swap
a. Increases in value
b. Decreases in value
c. Decreases in value only if the corporate bond is downgraded
d. Is unchanged in value
b. Decreases in value
A portfolio consists of one (long) $100 million asset and a default protection contract on this asset. The probability of default over the next year is 10% for the asset and 20% for the counterparty that wrote the default protection. The joint probability of default for the asset and the contract counterparty is 3%. Estimate the expected loss on this portfolio due to credit defaults over the next year with a 40% recovery rate on the asset and 0% recovery rate for the counterparty.
a. $3.0 million
b. $2.2 million
c. $1.8 million
d. None of the above
c. $1.8 million
When an institution has sold exposure to another institution (i.e., purchased protection) in a CDS, it has exchanged the risk of default on the underlying asset for which of the following?
a. Default risk of the counterparty
b. Default risk of a credit exposure identified by the counterparty
c. Joint risk of default by the counterparty and of the credit exposure identified by the counterparty
d. Joint risk of default by the counterparty and the underlying asset
d. Joint risk of default by the counterparty and the underlying asset
Which of the following is a type of credit derivative?
I. A put option on a corporate bond
II. A total return swap on a loan portfolio
III. A note that pays an enhanced yield in the case of a bond downgrade
IV. A put option on an off-the-run Treasury bond
a. I, II, and III
b. II and III only
c. II only
d. All of the above
a. I, II, and III
Which one of the following statements is most correct?
a. Payment in a total return swap is contingent on a future credit event.
b. Investing in a risky (credit-sensitive) bond is similar to investing in a risk-free bond plus selling a credit default swap.
c. In the first-to-default swap, the default event is a default on two or more assets in the basket.
d. Payment in a credit swap is contingent only upon the bankruptcy of the counterparty.
b. Investing in a risky (credit-sensitive) bond is similar to investing in a risk-free bond plus selling a credit default swap.
(Complex-use the valuation formula with prices) A credit-spread option has a notional amount of $50 million with a maturity of one year. The underlying security is a 10-year, semiannual bond with a 7% coupon and a $1,000 face value. The current spread is 120bp against 10-year Treasuries. The option is a European option with a strike of 130bp. If at expiration, Treasury yields have moved from 6% to 6.3% and the credit-spread has widened to 150bp, what will be the payout to the buyer of this credit-spread option?
a. $587,352
b. $611,893
c. $622,426
d. $639,023
c. $622,426
Bank One has made a $200 million loan to a software company at a fixed rate of 12%. The bank wants to hedge its exposure by entering into a total return swap with a counterparty, Interloan Co., in which Bank One promises to pay the interest on the loan plus the change in the market value of the loan in exchange for LIBOR plus 40bp. If after one year the market value of the loan has decreased by 3% and LIBOR is 11%, what will be the net obligation of Bank One?
a. Net receipt of $4.8 million
b. Net payment of $4.8 million
c. Net receipt of $5.2 million
d. Net payment of $5.2 million
a. Net receipt of $4.8 million
Which of the following transactions would be entered into in order to decrease credit risk with a specific counterparty?
a. Buy a call option on the counterparty’s common stock.
b. Sell a put option on the counterparty’s common stock.
c. Go long shares of the counterparty’s common stock.
d. Go short shares of the counterparty’s common stock.
d. Go short shares of the counterparty’s common stock.
The Widget Company has outstanding debt of three different maturities, as outlined in the table.
(may table too, Maturity: 1, 5, 10; Price: 100, 100, 100; Coupon: 7, 8.50, 9.50)
All Widget Co. debt ranks pari passu, all its debt contains cross-default provisions, and the recovery value for each bond is 20. The correct price for a one-year credit default swap (sa 30/360) with the Widget Co., 9.5% 10-year bond as a reference asset is
a. 1.0% per annum
b. 2.0% per annum
c. 2.5% per annum
d. 3.5% per annum
a. 1.0% per annum
The table below shows the bid-ask quotes by UBS for CDS spreads for companies A, B, and C. CSFB has excessive credit exposure to Company C and wants to reduce it through the CDS market.
(may table: 1 year: 15/25, 43/60, 71/84; 3 year: 21/32, 72/101, 93/113; 5 year: 27/36, 112/152, 141/170)
Since the farthest maturity of its exposure to C is three years, CSFB buys a USD 200 million three-year protection on C from UBS. In order to make its purchase of this protection cheaper, based on its views on companies A and B, CSFB decides to sell USD 300 million five-year protection on Company A and to sell USD 100 million one-year protection on Company B to UBS. What is the net annual premium payment made by CSFB to UBS in the first year?
a. USD 1.02 million
b. USD 0.18 million
c. USD 0.58 million
d. USD 0.62 million
a. USD 1.02 million
Which of the following are needed to value a credit swap?
I. Correlation structure for the default and recovery rates of the swap counterparty and reference credit
II. The swap or treasury yield curve
III. Reference credit spread curve over swap or treasury rates
IV. Swap counterparty credit spread over swap or treasury rates
a. II, II and IV
b. I, III and IV
c. II and III
d. All of the above
d. All of the above
Suppose that a bank, call it bank A, has made a $100 million loan to company XYZ at a fixed rate of 10%. The bank can hedge its exposure by entering a TRS with counterparty B, whereby it promises to pay interest on the loan plus the change in the market value of the loan in exchange for LIBOR plus 50bp.
If the market value of the loan decreases, the payment tied to the reference asset will become _____, providing a hedge for the bank.
- negative
- positive
negative
A credit spread option has a notional of $100 million with a maturity of one year. The underlying security is an 8% 10-year bond issued by the corporation XYZ. The current spread is 150bp against 10-year Treasuries. The option is European type with a strike of 160bp. Assume that, at expiration, Treasury yields have moved from 6.5% to 6% and the credit spread has widened to 180bp.
The price of an 8% coupon, 9-year semiannual bond discounted at y + S is:
A. 101.277
B. 102.574
C. 1,297,237
A. 101.277
