An investor believes that a bond may temporarily increase in credit risk. Which of the following would be the most liquid method of exploiting this? A) The purchase of a credit default swap. B) The sale of a credit default swap. C) The short sale of the bond. D) The purchase of a plain vanilla interest rate swap.
B) The sale of a credit default swap. Since the Cr. risk is temporary and will return to normal risk in long run, buy the bond and sell the credit default swap
ok but doesnt the value of the CDS go up when credit quality of the underlying deteriorates? Why not A then? Is it because it’s temporary? I dont get this.
you know what I think you are correct, I got it backwards… Short term instability = buy short term CDS, Long term sound prospect = sell lont term CDS, This question is not worded very nicely… hmmmm edit: barthez: what is the answere and the reasoning?
I am not sure though, it says “temporary increase in cr. risk” that does not mean bond will be defaulted in, which means CDS will not be exercised …so selling it might be collecting additional cash via the premium… I don’t know my gut says B but based on what I read A!!!
buying the bond is not a very liquid transaction
Dsylexic Wrote: ------------------------------------------------------- > buying the bond is not a very liquid transaction Yah forget buying the bond…I was thinking of something else, But I still think it should be B…as it is a temporary increase in cr. risk not a permanent which would cause a default which would cause an exercise on CDS. I am not sure though, it could be either way… so is it A or B?
Your answer: C was incorrect. The correct answer was A) The purchase of a credit default swap. If an investor believes the firms credit prospects are poor in the near term and wishes to capitalize on this, the investor should buy a credit default swap. Although a short sale of a bond could accomplish the same objective, liquidity is often greater in the swap market than it is in the underlying cash market. The investor could pick a swap with a maturity similar to the expected time horizon of the credit risk. By buying the swap, the investor would receive compensation if the bond experiences an increase in credit risk. Plain vanilla interest rate swaps provide positions in market-wide interest rate risk but not credit risk.
Yeps ans to barthezz’s questions is A (You need to buy protection) Here’s an easy one to top it up. Which of the following most accurately describes the appropriate position in credit default swaps and bonds? If an investor believes that credit risk is overstated by the market, the investor should: A) sell a bond or sell a credit default swap. B) buy a bond or sell a credit default swap. C) sell a bond or buy a credit default swap. D) buy a bond or buy a credit default swap.
This is an example of me trying to make a simple question difficult by looking too much into it…damn me…-1
C i like easy ones
B? I might be looking too much into it again but “credit risk is overstated by the market” meaning credit risk is actually lower and due to adjust as MKT are efficient…therefore I think this one is B
i’d like to be the seller of credit protection because the credit quality enhances. – > sell swap the bond should increase in value, … buy bond B
Correct - B is the answer
^ this is what I though of in the first question as it said the Cr. Risk was temporary…
dinesh, are you from india? if yes what’s the status of CFA exam in india? are you writing in india or you can’t anymore and have to travell to another country?
Yeps Van - I am originally from India, but residing in NYC. Will be taking the exam in Hilton Hotel, NY. But yes, for Indian candidated they are not allowed to take the exam from India, they have to travel international, to somewhere close like Singapore to take the test.
Holly crap dude, that means it’s about 4am there and you are studying…when did you start studying today?
dinesh started friday at 2AM - lots of redbull and pizza hut … also called CFA marathon…
Friday studied from 7 PM to morning 8AM. Then dozed off till 11 AM. Stated studying from Sat 11 AM to 9.30 PM and due to shifting apartments had to pack stuff from 9.30 PM to 1.30 AM and am back to books till 5 AM now. I am one of the marathon participants! But on a serious notes, don’t get enough time to study in weekdays so make the most of it in weekends.