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P2.T6.607. Credit default swaps (Crouhy)

Nicole Seaman

Director of FRM Operations
Staff member
Learning objectives: Describe the different types and structures of credit derivatives including credit default swap (CDS), first-to-default put, total return swaps (TRS), asset-backed credit-linked note (CLN), and their applications.


607.1. What did the 2009 Big Bang Protocol achieve?

a. Facilitated the determination of a credit event and the settlement of credit default swaps (CDS)
b. Established a cross-border protocol which began to facilitate the trading of sovereign credit default swaps (SCDS)
c .Introduced rules for swap execution facility (SEF) which provided a trading venue for interest rate and credit derivatives
d. Required the registration of non-cleared derivatives, such as cross-currency swaps, and meeting of minimum margin requirements

607.2. Each of the following statements is true about sovereign credit default swaps (SCDS) EXCEPT which is false?

a. The IMF found that, relative to comparable cash bond spread, SCDS spreads are approximately equivalent as indicators of sovereign credit risk
b. The March 2012 Greek debt exchange (i.e., sovereign default) was the largest payout of sovereign credit default swaps (CDS) in history, at the time
c. The 2012 European Union ban on all long or short covered positions in SCDS did "effectively obliterate" the SCDS market which had been shrinking rapidly since 2007
d. Sovereign credit default swaps (SCDS) are used to "proxy hedge," that is to hedge the risks of assets (such as domestic banks) whose value is correlated with the creditworthness of the sovereign

607.3. Financial Bank has a long position in bonds issued by Konkcore Corporation. To hedge the credit risk of this bond, Financial Bank enters a long position in an over-the-counter (OTC) credit default swap (CDS) with Counterparty Finservices, LLC. Which of the following is TRUE about the long position in the CDS?

a. If the price of Koncore's bond decreases due to a rise in interest rates, the value of the CDS will increase
b. If the yield on Konkore's bond increases due a rating downgrade, the value of the CDS will increase
c. If the default correlation between Konkcore and Counterparty increases, the value of the CDS will increase
d. If Konkore defaults on the bonds and settlement occurs in cash, the payoff on the CDS from Counterparty to Financial Bank is approximately the mid-market value of defaulted bonds as determined by auction process several days after the credit event

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