Question #16

Reading: Reading 29 Credit Default Swaps

PDF File: Reading 29 Credit Default Swaps.pdf

Page: 7

Status: Incorrect

Correct Answer: A

Your Answer: B

Part of Context Group: Q16-18 First in Group
Shared Context
- Which of the three statements in the introductory paragraph is correct? A) The statement describing the separation of credit and interest rate risk. B) The statement describing the bonds covered by a single name CDS. C) The statement describing the payoff on a credit event.
Question
Using the information under the heading "Illustration CTD," which of the three bonds would be the cheapest to deliver?
Answer Choices:
A. Bond Q
B. Bond P
Explanation
Bond Q is trading at the lowest price but the cheapest-to-deliver bond must rank pari passu with the reference obligation. Note that this is a CDS on a senior reference obligation and this bond is subordinated. Bond R has the same seniority as the reference obligation but trades at a higher price than Bond P. Note that there is no requirement for the CTD bond to have the same maturity as the reference obligation. Bond P has the same seniority as the reference obligation and trades at the lowest price. Payoff $15m – (0.45)($15m) = $8.25M.
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