Question #11 - 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

The most appropriate trade for the VAX bond is:

Answer Choices:

A. short the VAX bonds and buy the CDS

B. long the VAX bonds and buy the CDS

C. long the VAX bonds and sell the CDS

Explanation

This is a basis trade where the strategy is to exploit price differences between the bond market and the CDS market. The transaction is an arbitrage based on credit risk priced into the two products. Nathan will pick up 60 bps in yield when it buys the bond and buys the CDS. Nathan is also fully protected against credit risk.

Actions

Practice Flashcards