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4、The buyer of a credit default swap (CDS):

A) receives periodic payments after default equal to the promised payments on the defaulted bond. 

B) assigns the coupon payments from the loan to the issuer of the swap in exchange for a stated (but somewhat lower) string of guaranteed payments. 

C) makes periodic payments to the seller of the swap until a default occurs. 

D) makes a single payment to the seller of the swap at inception of the swap. 

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The correct answer is C

The buyer of the CDS makes periodic payments to the seller until a credit event such as a default occurs.

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5、Commercial Finance has lent $5 million to Barely, Inc. for one year at 7%, and entered into a credit default swap with Credit Insurers for 130 basis points. If the swap calls for semi-annual payments, what is due on the first payment assuming that no default has occurred?

A) Commercial Finance will pay Credit Insurers $32,500.

B) Credit Insurers will pay Commercial Finance $32,500.

C) Commercial Finance will pay Credit Insurers $207,500.

D) Commercial Finance will pay Credit Insurers $142,500.

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The correct answer is A

Commercial Finance will pay Credit Insurers the sum equal to: ($5 million) (0.013 / 2) = $32,500.

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6、From the swap seller’s perspective, a default swap creates a:

A) short position in the reference obligation. 

B) call position in the reference obligation. 

C) long position in the reference obligation. 

D) put position in the reference obligation. 

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The correct answer is C

From the swap seller’s perspective, a default swap creates a long position in the reference obligation. If the reference obligation increases in value or credit quality, the default swap decreases in value below the price at which it was originally sold.

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7、The buyer of a credit-default swap (CDS):

A) has no risk exposure to the combined holdings of the CDS and reference obligation.

B) must place collateral with the seller of the CDS to ensure performance. 

C) is subject to the credit risk of the seller.

D) can surrender the CDS for the value of the accumulated payments.

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The correct answer is C

The buyer of the CDS faces the risk that the seller may not be able to make the required payment if the reference obligation defaults. Two factors impact this risk: (1) if the probability of the reference obligation default increases with time, then so, too, may the probability of seller default, and (2) economic and operational factors may cause an increase in the correlation between the default of the reference obligation and the seller’s default.

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8、A default swap acts like a:

A) call option on the reference obligation for the buyer of the swap.

B) look back option on the reference obligation for the buyer of the swap.

C) up-and-out option on the reference obligation for the buyer of the swap.

D) put option on the reference obligation for the buyer of the swap.

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The correct answer is D

A default swap acts like a put option on the reference obligation for the buyer of the swap. If there is a default, the buyer receives a payment, which limits the buyer’s downside risk.