Get ready for CDO/CDS/Derivatives for Monday lunch.
Sounds hot & spicy, **burp** I’ll put the 33.33% probability rule to test tomm and see if it works for real.
man …u guys are posting at 2:00 AM , 3:00 AM 
Have you read this stuff already ditch? What are you, a CFA machine?
LOS Explanation A credit default swap (CDS) is essentially an insurance contract. The reference obligation is the fixed income security on which the swap is written—usually a bond but potentially also a loan. If default occurs on the reference obligation, the buyer of the swap receives a payment from the seller. To obtain this coverage, the buyer of the swap pays the seller a premium that is either paid up front or over a period of time. The buyer of the swap is said to be buying protection, whereas the seller is said to be selling protection and assuming credit risk. Credit default swaps are similar to bonds because when credit risk increases, both CDS premiums and bond yields increase. However, a corporate bond yield spread reflects compensation over the risk-free rate for two sources of risk: A spread reflecting the interest rate risk (also called funding risk) of the bond. A spread related to credit risk of the issuer. In contrast, credit default swaps only reflect the credit risk of the reference obligation, but not its interest rate risk. LOS Explanation Credit default swaps and other credit derivatives have a number of advantages over other credit instruments: Risk management: Credit derivatives allow credit risk to be managed separately from interest rate risk. Short positions: A short position can be taken in fixed income securities by buying a credit derivative. In contrast, shorting the underlying credit obligation can be challenging and cost prohibitive, especially if the obligation is in high demand in the repo market. Liquidity: The credit derivative market is more liquid than the underlying cash market. Over time, trading in CDSs has increased such that 3-, 5-, 7-, and 10-year maturity swaps are fairly liquid. Flexibility: Credit derivatives facilitate credit, maturity, and currency positions not otherwise available in the underlying cash market. For example, if an investor wanted a position with a 4-year maturity, a customized contract could be devised using 3- and 5-year maturity swaps. Confidentiality: Credit derivatives are confidential, over-the-counter contracts. In contrast, in a loan, the issuer has knowledge of the contract. LOS Explanation Commercial banks use credit derivatives to hedge their exposures arising from their loan portfolios and to satisfy regulators by buying credit protection. They are the largest participant in the market. Investment banks act as dealers in the credit derivatives market, providing liquidity to the rest of the market. They also use credit derivatives to hedge their corporate bonds, and they have trading desks that seek to exploit mispricing. Hedge funds now specialize in the trading of credit risk in addition to traditional convertible arbitrage and distressed debt opportunities. In their pursuit of relative value opportunities, they have become quite active and are important providers of liquidity to the market. Hedge funds represent the fastest growing segment of the credit derivatives market. Life insurance, property and casualty insurance, reinsurers, and monoline companies take long positions in credit by selling protection. LOS Explanation Basis trade: The CDS premium is compared to the asset swap spread of the underlying bond. The asset swap spread should reflect the credit risk of the bond. If it is higher than the CDS premium, the basis is negative and, to exploit the arbitrage opportunity, the investor should buy the bond and buy the CDS. Curve trade: The investor has different opinions than the market about the long- term versus short-term prospects for a bond issuer. In the flattener, the investor believes that the issuer has some short-term instability, but that its long-term prospects are sound. In the steepener, the investor believes that the issuer has the ability to subsist in the short term, but that its long-term prospects are poor. Index Trade: Credit indices represent opportunities to use CDS to exploit perceived mispricing. Credit index strategies include: 1) A short index position to hedge a portfolio or to exploit an expected increase in market-wide credit risk, 2) If an investor is bullish on a market or sector but bearish on particular issues, he could go long an index and short specific issues, and 3) If an investor is bearish on bonds and bullish on stocks, she could go short the credit index and long an equity index. Options Trade: There are European receiver options and payer options available in the market. These options will change in value as the value of the underlying changes. They can be used to provide leverage, hedge, take a position in volatility, or to create straddles and other option strategies. Capital Structure Trade: The investor uses CDSs to exploit different views on a firm’s various securities, as in the following examples: 1) The investor believes that a subsidiary has less credit risk than the parent, so he sells a CDS on the subsidiary and buys a CDS on the parent. 2) The investor uses his opinion on a firm’s recovery rates to sell a CDS on the firm’s subordinated debt and buy a cheaper CDS on the senior debt, earning the difference in the CDS premiums. 3) The investor has differing views on the firm’s debt and equity. Correlation Trade: Instead of selling protection on several individual CDSs, an investor could sell protection on a basket of CDSs. The higher the number of CDSs in the basket, the higher the basket’s premium. Higher spreads on the individual CDSs result in higher basket premiums. Higher default correlations result in lower premiums.
Which of the following most accurately describes the characteristics of options on credit default swaps? Options on credit indices are: A) less liquid than single issuer options and in a receiver option the option buyer has the right to buy a credit default swap. B) more liquid than single issuer options and in a receiver option the option buyer has the right to buy a credit default swap. C) more liquid than single issuer options and in a receiver option the option buyer has the right to sell a credit default swap.
B i haven’t looked at this stuff in a year… fuzzy.
Your answer: B was incorrect. The correct answer was C) more liquid than single issuer options and in a receiver option the option buyer has the right to sell a credit default swap. Options on credit indices are more liquid than single issuer options. In a receiver option, the option buyer has the right to sell a credit default swap (go long the underlying) at some future date. In a payer option, the option buyer has the right to buy a credit default swap (short the underlying) at some future date. These options will change in value as the value of the underlying changes. They can be used to provide leverage, hedge, take a position in volatility, or to create straddles and other option strategies.
Question 1 - 88445 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) sell a bond or buy a credit default swap. C) buy a bond or sell a credit default swap. -------------------------------------------------------------------------------- Question 2 - 88526 Which of the following most accurately describes the behavior of credit default swaps? A) When credit and interest rate risk increases, swap premiums increase. B) When credit risk increases, swap premiums increase, but when interest rate risk increases, swap premiums decrease. C) When credit risk increases, swap premiums increase. -------------------------------------------------------------------------------- Question 3 - 88446 A firm will potentially undergo a major financial restructuring where some of its debt may get downgraded. Which of the following positions would provide a bond investor protection against this event? A) The purchase of a credit default swap. B) The fixed side of a plain vanilla interest rate swap. C) The sale of a credit default swap.
Your answer: C was correct! To gain an exposure to credit risk, an investor could buy a bond or sell a credit default swap. When the market realizes that a bond has less credit risk than thought, the bond will rise in price. Alternatively, by selling the swap, the investor would receive a premium up front and owe no further compensation to the swap buyer if in fact the bond does not experience a credit event. Your answer: C was correct! When credit risk increases, credit default swaps increase in value because the protection they provide is more valuable. Credit default swaps do not provide protection against interest rate risk however. Your answer: A was correct! A credit default swap becomes more valuable when the reference obligation (e.g. a bond) decreases in credit quality. The credit events that trigger compensation from a credit default swap are usually defined as bankruptcy, entity default, and restructuring. The purchase of the swap provides the buyer compensation if a credit event occurs. Plain vanilla interest rate swaps protect against market-wide interest rate risk but not credit risk.
Q1. C (right to sell) 1. C (sell insurance…buy bond) 2. C (no IRR only CRR) 3. A (you would buy insurance, just in case the debt went bad)
duplicate posts
.
Question 1 - 88522 An investor would like to discreetly take a long position in a firm’s debt. Which of the following would be the most appropriate strategy? A) The purchase of a bond. B) The sale of a credit default swap. C) The purchase of a credit default swap. -------------------------------------------------------------------------------- Question 2 - 88521 Which of the following is least accurate regarding credit default swaps? A) The credit default swap market is highly regulated by government authorities. B) Liquidity is usually greater in the credit default swap market than in the underlying cash market. C) Short positions are more easily obtained using credit default swaps than shorting a bond. -------------------------------------------------------------------------------- Question 3 - 88523 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 sale of a credit default swap. B) The short sale of the bond. C) The purchase of a credit default swap.
B A C for the last 3? again, no shame in my game guessing even though i haven’t done derivs yet this year.
Q4. B Q5. A Q6. C
Your answer: B was correct! If an investor believes the firm’s credit prospects are good and wishes to discreetly capitalize on this by taking a long position, the investor should sell a credit default swap. Credit derivatives are confidential, over-the-counter contracts. By selling the swap, the investor would receive a premium up front and owe no further compensation to the swap buyer if in fact the debt does not experience credit risk. Your answer: A was correct! Credit default swaps are not highly regulated because they are confidential, over-the-counter contracts. Liquidity is often greater in the credit derivative market than it is in the underlying cash market. Your answer: A was incorrect. The correct answer was C) The purchase of a credit default swap. If an investor believes the firm’s 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.
Question 1 - 88505 Which of the following is least likely a stated use of credit derivatives by commercial banks and corporations? A) Speculation. B) Income. C) To satisfy regulatory standards. -------------------------------------------------------------------------------- Question 2 - 88516 Which of the following entities is the largest market participant in the credit derivatives market? A) Hedge funds. B) Commercial banks. C) Investment Banks. -------------------------------------------------------------------------------- Question 3 - 88500 Which of the following entities is the fastest growing segment of the credit derivatives market? A) Hedge funds. B) Commercial banks. C) Investment Banks.
Q7. B Q8. B Q9. A
charu_mulye Wrote: ------------------------------------------------------- > man …u guys are posting at 2:00 AM , 3:00 AM Yes. To quote an old friend Dinesh, money never sleeps pal. Dinesh originally coined this phrase in elementary school but Oliver Stone stole it claiming the fame for it in Wall Street. “Boys - never sleep! Sleeping is for cats. Just cram it till 8.00AM and believe me you won’t feel sleepy during the exam (For those drowsy eyes – just rip a RedBull or 2). Last few hours to go and you can’t sleep when the finish line is so near. Time to start sprinting now and peak midst of the exam tomorrow. I read Schweser till the proctor had to ask me ‘in’ and kept reading in the lunch break too. Every second counts now… That very precious minute that you sleep might cost you a brutal six more months. So wake up and get your ammos loaded. For few weak hearted reading my BS here, if you think you can’t do the night - just log off and mama will get you some Kellogg’s frosties for breakfast tomorrow (she promises). Don’t forget to leave the hall 2 minutes before 5.00 and grab the ‘I survived the CFA Exam’ T’s from the Schweser stall (talking NYC) - that’s a well deserved token of appreciation after the massacre of 240 bullets and 2 rounds of face-punching. Go Rocky Go - Just show those Charlottesville junta what mistake they have done by allowing you to register for this designation. Good Luck – I’ll be awake to keep you awake all night or till Chad shuts this website down (whichever occurs earlier). It’s 1.19AM ET and The music crescendos’ here.” http://www.analystforum.com/phorums/read.php?11,876241,876272#msg-876272