Question #17 - Reading 29 Credit Default Swaps

Reading: Reading 29 Credit Default Swaps

PDF File: Reading 29 Credit Default Swaps.pdf

Page: 8

Status: Incorrect

Correct Answer: A

Your Answer: B

Shared Context

- Using the information under the heading "Illustration CTD," which of the three bonds would be the cheapest to deliver? A) Bond Q. B) Bond P. C) Bond R.

Question

Using information in Exhibit 2, the gain on the position is closest to:

Answer Choices:

A. £1,080,000

B. £1,440,000

C. £4,320,000

Explanation

Step 1: Calculate the CDS spreads: upfront premium (%) = (credit spread – CDS coupon) × duration credit spread = (upfront premium / duration ) + CDS coupon At initiation: credit spread = (5 / 5) + 1 = 2% 1-year later: credit spread = (8 / 4) + 1 = 3% Step 2: Compute the approximate profit to the buyer as: profit for protection buyer ≈change in spread × duration ≈(0.03 – 0.02) × 4 × £36,000,000 profit ≈£1,440,000

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