Derek O'Brian with his quiz question of the day

CFA Level II
#1

Q1. 1 liner on each of the credit derivatives strategies below 1. Basis trade - 2. Curve trade - 3. Index Trade - 4. Options Trade - 5. Capital Structure Trade - 6. Correlation Trade -

#2

What is this level 3?? Wheres my A through D?? Basis Trade: Goal is to expoloit differences in pricing (Basis Points) between asset swap and CDS Curve Trade: Mispricings between long and short term porspects of a firm…(Buy Short term and sell long term or vise versa) Index Trade: Mispricings of index (Bullish on an index, can go long an index and short on specific issues if you believe some will underperform) Options Trade: In a receiver option, buyer has right to sell a CDS (long the underlying). If your bullish you would by a reciever option…Opposite for Payer Option Capital Structure Trade: Uses CDS to exploit different views on the capital sturcture of the firm. Ex. Sell a CDS on a subsidiary and buy a CDS on the parent Correlation Trade: Protection on a basket of CDSs…(Fairly difficult to understand…recommend reading again)

#3

nice work, chad! Here’s the gist of correlation trade: First-to-default-swap - protection for first default only. The higher the # of CDS in the basket, the higher the premium (higher chance of default), same with higher spreads on individual CDSs (reflecting greater credit risk). Default corr - probability that two of the reference obligations will default concurrently. High default corrrelations = lower premiums.

#4

Quick question about the capital structure trades: * If you are speculating on the recovery rate of the tranches, you could do the following: - Buy CDS on senior tranche while sell CDS on subordinate tranche. How this will generate the arbitrage profit? This is such a weird strategy. Why not just sell CDS on subordinated tranche?

#5

well, such ‘arbitrages’ are predicated on the idea that the analyst is 200% correct. ie. correct about the direction both senior and subordinated tranches are headed. if things dont pan out, the investor loses doubly.

#6

Thankssssssssssss chadtap and lola for a quick refrsher on this!