Topic 21: Credit Risks and Credit Derivatives

Test ID: 8829482

Question #1 of 38

Question ID: 384130

What risk describes a credit derivative buyer or seller NOT fulfilling their agreement?
A) Operational risk.
B) Liquidity risk.
C) Counterparty risk.
D) Pricing risk.

Question #2 of 38

Question ID: 440077

Which of the following is NOT a credit event that would trigger payment on a default swap?
A) The issuer disavows her obligation to pay.
B) The payment's seniority is a reduced.
C) A credit downgrade by a bond-rating agency.
D) Obligation acceleration.

Question #3 of 38

Question ID: 440086

Credit risk in a swap can be reduced by:

I. requiring a margin.
II. netting payments between parties.
III. full two-way payment covenant.
IV. limited two-way payment covenant.

A) I, II, and III only.

B) II and III only.
C) II and IV only.
D) I and IV only.

Question #4 of 38

Question ID: 440053

When determining credit risk spread, the benchmark security is most likely a(n):
A) Treasury bond.
B) low-yield corporate bond.
C) AA rated bond.

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D) high-yield corporate bond.

Question #5 of 38

Question ID: 440071

The total return payer in a total return swap (TRS) must pay the total return buyer:
A) the total bond return minus the coupon payments.
B) a floating rate payment usually based on the London Interbank Offered Rate (LIBOR).
C) the total bond return.
D) only the coupon payments and any principal received from the bond.

Question #6 of 38

Question ID: 384118

Which of the following statements concerning a credit default swap is FALSE?

A) It is a private contract between a buyer and seller.
B) The contract size is established by the International Swaps and Derivatives Association (ISDA).
C) It acts as an insurance policy for the buyer against a company defaulting on its bonds.
D) It is comparable to a credit put option.

Question #7 of 38

Question ID: 412176

Which of the following is least likely a characteristic of credit default swaps? Credit default swaps:
A) are similar to a credit put option.
B) trade on an exchange.
C) transfer credit risk exposure.
D) payoff if a credit event occurs.

Question #8 of 38

Question ID: 440068

Commercial Finance has lent $5 million to Barely, Inc. for one year at 7%, and entered into a credit default swap with Credit
Insurers for 130 basis points. If the swap calls for semi-annual payments, what is due on the first payment assuming that no
default has occurred?
A) Commercial Finance will pay Credit Insurers $142,500.
B) Commercial Finance will pay Credit Insurers $207,500.
C) Credit Insurers will pay Commercial Finance $32,500.
D) Commercial Finance will pay Credit Insurers $32,500.

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Question #9 of 38

Question ID: 440063

Which of the following CORRECTLY describes the total return receiver in a total return credit swap? The total return receiver will:

A) diversify default risk.

B) hedge interest rate risk.
C) hedge credit exposure.
D) increase credit exposure.

Question #10 of 38

Question ID: 440087

Bank A has just entered into a plain vanilla interest rate swap with Bank B as the pay-fixed counterparty. Bank B is the
receive-fixed counterparty. The forward spot curve is upward sloping. Assuming that LIBOR starts trending down, the credit risk
from the swap will:
A) increase for Bank A and decrease for Bank B.
B) increase for Bank A only.
C) decrease for both banks.
D) increase for Bank B only.

Question #11 of 38

Question ID: 440056

Suppose a levered firm (with only one debt issue) is experiencing financial distress and that the firm's value of debt is affected by
unanticipated changes in interest rates. Also suppose that the long-run mean of interest rates is higher than the current interest
rate. Which of the following statements is (are) consistent with the models that include variables that measure interest rate
dynamics?

I. The value of debt will increase if the volatility of interest rates declines.
II. The value of debt will increase if the correlation between the firm value and changes in interest rates increases.
III. The value of debt will increase if the speed of mean reversion of interest rates increases.
A) I and II.
B) I and III.
C) I only.
D) II only.

Question #12 of 38

Question ID: 440070

The total return payer (credit risk seller) in a total return swap (TRS) is exposed to:
A) the credit risk of the issuer of the debt obligation.
B) the credit risk of the credit risk buyer.

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C) the interest-rate risk of the debt obligation.

D) paying floating rate payments.

Question #13 of 38

Question ID: 440083

All of the following can be accomplished with the use of a credit derivative EXCEPT:
A) allowing a fund to invest in corporate loans.
B) reducing credit concentration risk.
C) preventing the bankruptcy of loan counterparty.
D) leveraging credit risk.

Question #14 of 38

Question ID: 440074

A credit default swap does NOT hedge against which of the following risks?
A) Default risk.
B) Operations risk.
C) Credit Deterioration.
D) Market.

Question #15 of 38

Question ID: 440079

A first-to-default put:
A) compensates the buyer in case one of the assets in a specified pool defaults.
B) All of these.
C) is valued by obtaining the implied default volatilities in the broker market.
D) returns the maximum of the difference between the strike level and the remaining market value of the
first-to-default loan or zero.

Question #16 of 38

Question ID: 440069

The buyer of a credit default swap (CDS):

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A) makes periodic payments to the seller of the swap until a default occurs.
B) assigns the coupon payments from the loan to the issuer of the swap in exchange for a stated (but
somewhat lower) string of guaranteed payments.
C) receives periodic payments after default equal to the promised payments on the defaulted bond.
D) makes a single payment to the seller of the swap at inception of the swap.

Question #17 of 38

Question ID: 440062

The credit derivative that can hedge the most types of risk is most likely the:
A) basket default swap.
B) credit spread forward.
C) credit default option.
D) total return swap.

Question #18 of 38

Question ID: 440059

A seller must make a payment to the credit protection buyer based on a trigger event. According to the International Swaps and
Derivatives Association (ISDA), all of the following are trigger events EXCEPT a:
A) repudiation/moratorium.
B) restructuring.
C) obligation acceleration.
D) stock split.

Question #19 of 38

Question ID: 440054

The expected value of a firm at maturity due to an increase in the risk-free rate and a decrease in the delta of a call option on the
firm, respectively:

Risk-Free Rate

Decrease in
delta

A) Increases

Decreases

B) Decreases

Increases

C) Decreases

Decreases

D) Increases

Increases

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Question #20 of 38

Question ID: 440085

Which of the following statements is CORRECT?

A) Payment from the seller to the buyer in a credit swap is not contingent upon a future credit event.
B) Payment from the seller to the buyer in a credit swap is contingent upon a future credit event and
payment from the seller to the buyer in a total rate of return swap is not contingent upon a future
credit event.
C) None of these.
D) Payment from the seller to the buyer in a total rate of return swap is contingent upon a future credit
event.

Question #21 of 38

Question ID: 440065

The most that the buyer of a credit default swap can expect to receive in the event of a default is:
A) interest and principal payments as originally scheduled.
B) the par value of the instrument.
C) a premium price for the instrument.
D) 85% of the originally scheduled payments.

Question #22 of 38

Question ID: 440075

A default swap acts like a:

A) put option on the reference obligation for the buyer of the swap.
B) look back option on the reference obligation for the buyer of the swap.
C) call option on the reference obligation for the buyer of the swap.
D) up-and-out option on the reference obligation for the buyer of the swap.

Question #23 of 38

Question ID: 440058

In a total return swap, the:

A) total return receiver transfers the risk of holding the reference asset to the total return payer.
B) total return payer bears the risk of holding the reference asset.
C) credit risk of the buyer and seller cancel each other out.
D) total return payer transfers the risk of holding the reference asset to the total return receiver.

Question #24 of 38

Question ID: 440084

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Which of the following events is NOT a credit event?

A) Downgrading.
B) Bankruptcy.
C) Calling back a bond.
D) Default on payments.

Question #25 of 38

Question ID: 440073

An investor purchases 300,000 of ABC Corps bonds with an annual coupon of 8% and maturity of 5 years. The yield is 8% so
the bonds are selling at par. The total notional amount of the bonds is $30,000,000. The investor hedges 80% of the position by
becoming a total rate of return swap (TROR) payer. ABC's computer system is hacked and the firm's bonds decrease in price
from $100 to $90. What is the payoff to the TROR total rate of return swap due to the increase in operations risk?
A) $2,400,000.
B) $3,000,000.
C) $2,100,000.
D) $1,700,000.

Question #26 of 38

Question ID: 440076

The buyer of a credit-default swap (CDS):

A) must place collateral with the seller of the CDS to ensure performance.
B) has no risk exposure to the combined holdings of the CDS and reference obligation.
C) can surrender the CDS for the value of the accumulated payments.
D) is subject to the credit risk of the seller.

Question #27 of 38

Question ID: 440057

The nave model and the Merton model, respectively, work better in predicting whether debt is riskless for:
Nave model

Merton model

A) Investment grade bonds Junk bonds

B) Junk bonds

Coupon bonds

C) Junk bonds

Investment grade bonds

D) Zero-coupon bonds

Coupon bonds

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Question #28 of 38

Question ID: 440080

Assuming perfect correlation, which of the following instruments provides value protection if the market value of an asset being
hedged declines?
A) Letter of credit.
B) Total return swap.
C) Basket default option.
D) Credit default swap.

Question #29 of 38

Question ID: 440061

An investor can gain the exposure and return of an underlying loan by:
A) being the credit risk buyer in a total return swap.
B) being the credit risk seller in a total return swap.
C) entering into an interest-rate swap with a BB credit.
D) pledging compensating balances with the lender bank.

Question #30 of 38

Question ID: 440078

One difference between a credit default swap and a total return swap is:
A) one is a credit derivative; the other is not.
B) one provides a reduction in capital; the other does not.
C) one provides an enhanced return to the investor; the other does not.
D) None of these.

Question #31 of 38

Question ID: 440081

Company A and Company B enter into a trade agreement in which Company A will periodically pay all cash flows and capital
gains arising from Bond X to Company B. On the same dates Company B will pay Company A LIBOR + 50bp plus any decrease
in the market value of Bond X. What type of trade is this?
A) An inverse floater.
B) A total return swap.
C) A fixed income linked swap.
D) An interest rate swap.

Question #32 of 38

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Question ID: 440082

In the first-to-default swap, the default event is a default on:

A) None of these.
B) any one of the assets in the basket.
C) two or more assets in the basket.
D) all of the assets in the basket.

Question #33 of 38

Question ID: 440060

Which of the following is (are) a credit event?

I. Failure to make a required payment.

II. Restructuring that makes the creditor worse off.
III. Bankruptcy.
IV. Invocation of a cross-default clause.
A) I, II, III, and IV.
B) I, II, and IV.
C) I, II, and III.
D) II and III.

Question #34 of 38

Question ID: 440055

A bond with a face value of 350 matures in 10 years and is calculated to be worth 180 using the Merton model. The risk-free rate
is 5.5%. What is the bond's spread?
A) 3.55%.
B) 1.75%.
C) 6.65%.
D) 1.15%.

Question #35 of 38

Question ID: 440064

Which of the following credit derivatives would hedge market-wide interest rate risk?
A) A TROR.
B) Credit spread put.
C) Credit spread forward.
D) Credit spread swap.

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Question #36 of 38

Question ID: 440066

Which of the following would most likely be settled with one party requiring the other to purchase the underlying asset?
A) A credit default swap.
B) Subordinate basket default swap.
C) Senior basket default swap.
D) A total return swap.

Question #37 of 38

Question ID: 440067

From the swap seller's perspective, a default swap creates a:

A) short position in the reference obligation.
B) long position in the reference obligation.
C) call position in the reference obligation.
D) put position in the reference obligation.

Question #38 of 38

Question ID: 440072

Which of the following is NOT listed as an International Swaps and Derivatives Association default trigger for payment under a
credit default swap?
A) Obligation default.
B) A downgrade from a ratings agency.
C) Failure to Pay.
D) Bankruptcy.

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