Which of the following scenarios offer an example of wrong way risk?
A) A bank purchases credit protection on highly-rated tranches of US mortgage-backed securities from a US mortgage bank
B) A bank sells protection on the iTraxx main index at a level of 25 bps and shortly afterwards the index crosses the 200 bps level
C) A bank sells EUR put I USD call ATM options with an expiry date of 6 months and afterwards volatility moves up to substantially higher levels
D) A bank enters into a receiver's swap while interest rates are increasing

Question

Quizplus · Accepted Answer

Wrong way risk occurs when exposure to a counterparty is adversely correlated with the credit quality of that counterparty. In scenario A, the bank is purchasing credit protection from a mortgage bank on mortgage-backed securities, which means if the mortgage market deteriorates, the counterparty's ability to pay may also deteriorate, creating wrong way risk.

Which of the Following Scenarios Offer an Example of Wrong