A digital default option
A)always pays the par value of a loan if exercised.
B)has a payout that is capped at 80 percent of the par value of the loan.
C)will cause the FI never to lose more than the premium paid to purchase the option.
D)always pays the par value of a loan if exercised and will cause the FI never to lose more than the premium paid to purchase the option.
E)always pays the par value of a loan if exercised and has a payout that is capped at 80 percent of the par value of the loan.

Question

Quizplus · Accepted Answer

A digital default option always pays the par value of a loan if exercised and also limits the loss for the FI to the premium paid to purchase the option. Therefore, option D is the correct choice as it encompasses both of these characteristics. Option A and E are partially correct but do not include the limitation of loss for the FI. Option B is incorrect as it limits the payout to 80 percent of the par value, which may not always be the case with a digital default option. Option C is also incorrect as it only refers to the limitation of loss and does not include the payout characteristic.

A Digital Default Option