Question 1

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-if deem advisors enters into a new offsetting contract two months after purchasing the CdS protection on Kand Corporation, this action will most likely result in:&#10;A) a loss on the CdS position.&#10;B) a gain on the CdS position.&#10;C) neither a loss or a gain on the CdS position.

Accepted Answer

When the credit spread for Kand Corporation increased by 200 basis points after the purchase of the CDS, the perceived risk of default by Kand Corporation increased. This makes the CDS more valuable because it provides protection against this higher perceived risk. Therefore, entering into an offsetting contract at this point would likely result in a gain on the CDS position, as the cost to buy similar protection has increased.

Question 2

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

The probability of defaulting on the bond during the first three years can be calculated using the hazard rates for each year and the formula for cumulative probability of survival. The cumulative probability of default is 1 minus the product of the survival probabilities for each year: $1 - (1-0.0022) \times (1-0.0035) \times (1-0.0050) = 1 - 0.9893 \times 0.9965 \times 0.9950 \approx 0.0107$ or 1.07%.

Question 3

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

A CDS index would allow the SWF to hedge multiple fixed-income exposures simultaneously, as it includes a basket of entities, providing broader coverage than a single-name CDS.

Question 4

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-based on exhibit 1, the upfront premium as a percent of the notional for the CdS protec- tion on Kand Corp. would be closest to:&#10;A) 2.0%.&#10;B) 9.8%.&#10;C) 14.0%.

Accepted Answer

The upfront premium is calculated as the difference between the credit spread and the coupon rate, multiplied by the duration. Here, (700 bps - 500 bps) * 7 years = 1400 bps or 14.0%.

Question 5

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

A profitable equity-versus-credit trade involving Delta and Zega, given the anticipation of Delta making an unsolicited bid for Zega, would be to go long on Zega shares (expecting their value to increase due to the bid premium) and short Delta 5-year CDS (anticipating that Delta's creditworthiness might decrease due to the increased debt from the acquisition, which would increase the value of the CDS position).

Question 6

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-Should watt conclude that uNab experienced a credit event?&#10;A) Yes.&#10;B) No, because uNab did not file for bankruptcy.&#10;C) No, because the failure to pay occurred on a subordinated unsecured bond.

Accepted Answer

The failure to make a scheduled interest payment after a grace period constitutes a credit event under typical CDS contracts, regardless of whether the failure occurred on a senior or subordinated bond or whether the company filed for bankruptcy.

Question 7

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

The gain from the hypothetical Orion trade is calculated based on the narrowing of the credit spread from 150 bps to 100 bps. This reduction in the credit spread would result in a gain for the fund, as it sold protection and the risk of default perceived in the market decreased. The specific gain amount of £117,000 is derived from the details provided about the trade and the change in the credit spread.

Question 8

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

To close the position on the hypothetical Orion trade, the fund would buy protection at a lower premium than it received at the start of the trade. This is because the fund initially sold protection (received a premium) and to close the position, it would buy protection back, ideally at a lower premium due to the narrowed credit spread, thus realizing a profit.

Question 9

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

Based on the outlooks provided, the most profitable long/short trade aligns with the expectation that the credit quality of electric car manufacturers will improve relative to that of traditional car manufacturers. This scenario suggests that the credit spreads of electric car companies will narrow (improve) compared to those of traditional car companies. Therefore, going long on electric car CDS (betting on improving credit quality) and shorting traditional car CDS (betting on relative deterioration or less improvement in credit quality) would capitalize on this outlook. Choices A and C do not directly align with the provided economic outlooks.

Question 10

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-based on basis trade for tollunt Corporation, if convergence occurs in the bond and CdS markets, the trade will capture a profit closest to:&#10;A) 0.25%.&#10;B) 1.75%.&#10;C) 2.75%.

Accepted Answer

The answer of On 1 January \(20 \mathrm { X...

Question 11

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

The answer of The following information relates to Questions &#10;John...

Question 12

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-according to watt's statement, the shape of uNab's credit curve is most likely:&#10;A) flat.&#10;B) upward-sloping.&#10;C) downward-sloping.

Accepted Answer

The answer of On 1 January \(20 \mathrm { X...

Question 13

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

The answer of The following information relates to Questions &#10;John...

Question 14

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf), meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS),to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS)transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.

-based on exhibit 1, the probability of orion defaulting on the bond during the first three years is closest to:

A) 1.07%.
B) 2.50%.
C) 3.85%.

1.07%.

Accepted Answer

The answer of The following information relates to Questions &#10;John...

Question 15

On 1 January $20 \mathrm { X } 2$, Deem Advisors purchased a $\$ 10$ million six-year senior unsecured bond issued by UNAB Corporation. Six months later (1 July 20X2), concerned about the portfolio's credit exposure to UNAB, Doris Morrison, the chief investment officer at Deem Advisors, purchases a $\$ 10$ million CDS with a standardized coupon rate of $5 \%$. The reference obligation of the CDS is the UNAB bond owned by Deem Advisors.&#10;&#10;On 1 January 20X3, Morrison asks Bill Watt, a derivatives analyst, to assess the current credit quality of UNAB bonds and the value of Deem Advisors' CDS on UNAB debt. Watt gathers the following information on UNAB's debt issues currently trading in the market:&#10;&#10;Bond 1: A two-year senior unsecured bond trading at $40 \%$ of par&#10; Bond 2: A six-year senior unsecured bond trading at $50 \%$ of par &#10;Bond 3: A six-year subordinated unsecured bond trading at $20 \%$ of par With respect to the credit quality of UNAB, Watt makes the following statement:&#10;&#34;There is severe near-term stress in the financial markets and UNAB's credit curve clearly reflects the difficult environment.&#34;&#10;&#10;On 1 July 20X3, UNAB fails to make a scheduled interest payment on the outstanding subordinated unsecured obligation after a grace period; however, the company does not file for bankruptcy. Morrison asks Watt to determine if UNAB experienced a credit event and, if so, to recommend a settlement preference.&#10;&#10;Kand Corporation&#10;&#10;Morrison is considering purchasing a 10-year CDS on Kand Corporation debt to hedge its current portfolio position. She instructs Watt to determine if an upfront payment would be required and, if so, the amount of the premium. watt presents the information for the CdS &#10;in exhibit 1.&#10; $$\begin{array}{l}&#10;\text { EXHIBIT } 1 \text { Summary Data for 10-year CDS on Kand Corporation }\&#10;\begin{array} { l l } &#10;\hline \text { Credit spread } & 700 \text { basis points } \&#10;\text { Duration } & 7 \text { years } \&#10;\text { Coupon rate } & 5 \% \&#10;\hline&#10;\end{array}&#10;\end{array}$$ Morrison purchases the 10-year CdS on Kand Corporation debt. two months later the credit spread for Kand Corp. has increased by 200 basis points. Morrison asks watt to close out the firm's CdS position on Kand Corporation by entering into new offsetting contracts.&#10;Tollunt Corporation deem advisors' chief credit analyst recently reported that tollunt Corporation's five-year bond is currently yielding 7% and a comparable CdS contract has a credit spread of 4.25%. Since libor is 2.5%, watt has recommended executing a basis trade to take advantage of the pricing of tollunt's bonds and CdS. The basis trade would consist of purchasing both the bond and the CdS contract.&#10;&#10;-if uNab experienced a credit event on 1 July, watt should recommend that deem advisors:&#10;A) prefer a cash settlement.&#10;B) prefer a physical settlement.&#10;C) be indifferent between a cash or a physical settlement.

Accepted Answer

The answer of On 1 January \(20 \mathrm { X...

Deck 11: Credit Default Swaps