CRT.1

Question 1

2 main families of CDS indices

Answer 1

(a) CDX indices contain North American and Emerging Market companies - administered by CDS Index Company (CDSIndexCo) and marketed by Markit Group Limited
(b) iTraxx contain companies from the rest of the world managed by the International Index Company (IIC)and owned by Markit

Question 2

LIBOR

Answer 2

London Interbank Offered Rate - an interest rate fixing in the interbank market, representing the rate at which highly-rated banks will lend to one another

Question 3

Recovery Rate

Answer 3

Estimate of percentage of par value that bondholders will receive after a credit event. CDS for
investment grade bonds generally assume a 40% recovery rate when valuing CDS trades.

Question 4

Credit Spread (Bond)

Answer 4

The yield spread between different securities due to the different credit quality. The credit spread of a particular security is often quoted in relation to the yield on a credit risk-free benchmark security or reference rate, typically either U.S. Treasury bonds or LIBOR

Question 5

Senior debt of Corporate bond

Answer 5

Debt that takes priority over other unsecured or ““junior”” debt owed by the issuer. Senior debt has greater seniority in the issuer’s capital structure than subordinated debt. In the event the issuer goes bankrupt, senior debt theoretically must be repaid before other creditors receive any payment

Question 6

Tier

Answer 6

Refers to one of four levels of debt in the capital structure of the reference entities. Each tier represents a
different level of seniority or preference in liquidation or
bankruptcy. There will generally be different levels for CDS
protection for each of the tiers:
Senior, Subordinated, Junior, Preferred

Question 7

Short Credit

Answer 7

This is the credit risk position of the Protection Buyer, who sold the credit risk of a bond to the Protection Seller.

Question 8

Protection Seller

Answer 8

This is the party to a CDS contract receiving the premium payments, and who is exposed to the
credit risk of the reference entity.

Question 9

Protection Buyer

Answer 9

This is the party to a CDS contract which pays a premium for protection in case a credit event occurs. The Protection Buyer can also speculate that the cost of protection will rise and profit from selling the CDS contract at a higher price than was paid.

Question 10

Markit RED

Answer 10

Markit’s Reference Entity Database. Markit RED is the industry standard identifier for reference
entities and reference obligations in the credit derivative market.

Question 11

Markit iTraxx

Answer 11

European and Asian CDS indices owned by Markit. The Markit iTraxx represents the most liquid part
of the CDS market for Asia and Europe.

Question 12

Markit CDX

Answer 12

Markit credit indices focused on North America. Investment Grade, High Yield, and Emerging Markets
are the three major sub-indices.

Question 13

JPY equivalent of LIBOR

Answer 13

TIBOR

Question 14

EUR equivalent of LIBOR

Answer 14

EURIBOR

Question 15

LCDS

Answer 15

A CDS contract where the underlying instrument is a syndicated loan, senior secured in the capital structure.

Question 16

ISDA

Answer 16

The International Swaps and Derivatives Association is the global trade association representing participants in the privately negotiated derivatives industry. A business covering swaps and options across all asset classes (interest rates, currency, commodity, energy, credit, equity)

Question 17

Index Roll

Answer 17

Process which, for Markit iTraxx and Markit CDX indices, take place twice a year in March and September to create a new index series.

Question 18

DTCC

Answer 18

Depository Trust & Clearing Corporation. It provides clearance, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities and OTC derivatives

Question 19

CDS Spread

Answer 19

The amount paid by protection buyer to protection seller, typically denominated in basis points and paid quarterly.

Question 20

credit default swap index

Answer 20

A credit derivative used to hedge credit risk or to take a position on a basket of credit entities. A completely standardised credit security and more liquid and trade at a smaller bid-offer spread.

Question 21

Subordinated debt (Corporate bond)

Answer 21

Subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, and ranks below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors.

Question 22

Distressed securities

Answer 22

Distressed securities are securities of companies or government entities that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition.

Question 23

Commerical Paper

Answer 23

Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation’s promise to pay the face amount on the maturity date specified on the note.

Question 24

Credit Default Swaps

Answer 24

A financial swap agreement that the seller of the CDS will compensate the buyer in the event of a loan default or other credit event. The buyer of the CDS makes a series of payments (the CDS fee or spread) to the seller and, in exchange, receives a payoff if the loan defaults.

Question 25

3 examples of credit events

Answer 25

Bankruptcy, Failure to Pay, Restructuring

Question 26

credit default swaption or credit default option

Answer 26

an option to buy protection (payer option) or sell protection (receiver option) as a credit default swap on a specific reference credit with a specific maturity. The option is usually European, exercisable only at one date in the future at a specific strike price defined as a coupon on the credit default swap.

Question 27

Basket CDS

Answer 27

a CDS where a group of reference entities are specified in one contract, eg. first or Nth-to-default swaps (where settlement is triggered when the first or Nth entity defaults)

Question 28

credit linked notes (CLN)

Answer 28

It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk to credit investors. The issuer is not obligated to repay the debt if a specified event occurs. This eliminates a third-party insurance provider. It is issued by a special purpose company or trust, designed to offer investors par value at maturity unless the referenced entity defaults. In the case of default, the investors receive a recovery rate.

Question 29

credit spread

Answer 29

The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.

Question 30

credit spread option

Answer 30

A financial derivative contract that transfers credit risk from one party to another. An initial premium is paid by the buyer in exchange for potential cash flows if a given credit spread changes from its current level. The buyer of a credit spread option will receive cash flows if the credit spread between two specific benchmarks widens or narrows. Credit spread options come in the form of both calls and puts, allowing both long and short credit positions.

Question 31

Basis point

Answer 31

1/100th of 1%. 100 basis points = 1%

Question 32

Upfront

Answer 32

Refers to the initial (i.e. upfront) lump sum payment made when entering a CDS transaction. Upfront payments tend to apply to transactions where the credit quality of the entity referenced is poor