invic

Which of the following is least accurate regarding credit default swaps?

A) The credit default swap market is highly regulated by government authorities.

B) Liquidity is usually greater in the credit default swap market than in the underlying cash market.

C) Short positions are more easily obtained using credit default swaps than shorting a bond.

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Credit default swaps are not highly regulated because they are confidential, over-the-counter contracts. Liquidity is often greater in the credit derivative market than it is in the underlying cash market.

invic

firm will potentially undergo a major financial restructuring where some of its debt may get downgraded. Which of the following positions would provide a bond investor protection against this event?

A) The fixed side of a plain vanilla interest rate swap.

B) The sale of a credit default swap.

C) The purchase of a credit default swap.

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A credit default swap becomes more valuable when the reference obligation (e.g. a bond) decreases in credit quality. The credit events that trigger compensation from a credit default swap are usually defined as bankruptcy, entity default, and restructuring. The purchase of the swap provides the buyer compensation if a credit event occurs. Plain vanilla interest rate swaps protect against market-wide interest rate risk but not credit risk.