Hey, in concept check in my CFA book 5 it asked: Distinguish between the risks transferred via a total return swap in contrast to the risks transferred via a credit default swap.? I can guess CDS/TRS benefits sellers in pension plans. Any other ideas?
The way I understand it is that TRS transfers risk of loss in total asset value. CDS transfers default risk only (its essentially bond insurance).
They are asking you to distinguish the risks transferred. A CDS only transfers the risk associated with a credit event including a default, restructuring, etc… A total return swap transfers all the risk associated with the price of the bond as well as the interest payments. Thus, you can own a bond and a CDS and be getting whacked because of some problem other than default risk. That can’t happen in a total return swap.
Sam has given a loan of $10 million to Linda in return for 10% interest payments annually. Now, he enters into a contract with Danny where Sam pays Danny $0.7 million each year until the maturity of the loan, but if Linda fails to repay the loan Danny has to repay him $10 million as well as any remaining interest. What type of credit derivative is this? - i have the answer as CDS -but it looks more like a TRS
Daany and Sam = CDS
Sam pay regular payments (premiums)
and receives payoff in case of default of underlying loan/bond.
“as well as any remaining interest”
This is what confused me