Credit spread call options are useful because
A)its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread.
B)an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases.
C)they will always cause a loss at least equal to the required premium on the option.
D)All of the above.
E)Answers A and B only.

Question

Quizplus · Accepted Answer

Credit spread call options are useful because their value increases when the risk premium on a benchmark bond of the borrower increases above the exercise spread, providing a hedge against credit risk. An increase in the value of the call option tends to offset the decreasing value of the loan and net worth of the financial institution as the credit quality of the borrower decreases. However, credit spread call options can also incur a loss if the credit spread does not widen, leading to a premium paid for an option that is never exercised, hence why option pricing models are used to determine the fair premium to pay for such options.

Credit Spread Call Options Are Useful Because