Question #10 - Reading 29 Credit Default Swaps

Reading: Reading 29 Credit Default Swaps

PDF File: Reading 29 Credit Default Swaps.pdf

Page: 4

Status: Unattempted

Correct Answer: A

Shared Context

- Assume that Nathan sells $400 million of protection on the equally weighted CDX IG index which consists of 125 entities. Concerned about the creditworthiness of an entity A, he purchases $2 million of single-name CDS protection on entity A. What is the investor's net notional exposure to Company A? A) $1.2 million. B) $3.2 million. C) $2.0 million.

Question

Describe a potential curve trade that Nathan could use to hedge the default risk of ABC Company.

Answer Choices:

A. Nathan should position himself short in the short term CDS and short in the long term CDS

B. Nathan should position himself long in the short term CDS and short in the long term CDS

C. Nathan should position himself short in the short term CDS and long in the long term CDS

Explanation

The investor anticipates a flattening curve and can exploit this possibility by positioning himself short (buying protection) in the two year CDS while going long in the five-year CDS (selling protection).

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