Credit spread option quiz option, Because, therefore, necessary

jcole21

Why is a risk factor necessary in credit derivatives whose payout is dependent on changes to the credit spread?

Possible answers:

A: Because it reflects the extra uncertainty inherent in non-investment grade bonds
B: Because it reflects the bond's modified duration and therefore its sensitivity to yield changes
C: To enable gearing
D: Because changes to the credit spread are small and spread derivative bets are for large amounts of money

Colum

A.
B is like a yield beta.

mik82

and it is B and B and B

because I say it is B

:-)



Edited 1 time(s). Last edit at Thursday, May 12, 2011 at 08:38AM by pfcfaataf.

zwjy

cuz the CFAI said so..............isay the answer is B

wake2000

The answer is: B

The risk factor is the bond's modified duraton. This means payouts from the spread derivatives should be sufficient to cover value changes in the underlying bond.

Windjammer

Damn, I guessed A. That was pretty tricky.

NO EXCUSES

NakedPuts2011

You guys rock!

Duration is a Primary Risk Factor, but yield beta is not...man, simply memorizing a term didn't work.

bodhisattva

The "risk factor" discussed here is number used in payout formula (check credit derivatives in volume 4)...

liangfeng

B is the best possible answer.

"the risk factor is the value change of the security for a one basis point change in the credit spread." (V4, p. 125).