Question #18

Reading: Reading 29 Credit Default Swaps

PDF File: Reading 29 Credit Default Swaps.pdf

Page: 8

Status: Incorrect

Correct Answer: A

Your Answer: C

Part of Context Group: Q17-18
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
Which of the comments relating to the credit curve is least accurate?
Answer Choices:
A. The definition of the credit curve
B. The description and example of the naked CDS position
C. The description and example of the curve trade
Explanation
The definition of the credit curve is accurate. The definition of the naked CDS position is also correct. Be careful here because the purchaser of the CDS is said to be taking a short position in credit risk. This seems counter intuitive as we normally describe a purchaser as long and a seller as short. The definition of a curve trade is correct, however, the example is incorrect. If we believe that the credit condition of the reference entity will improve over time we should purchase protection in a short maturity CDS and sell protection in a long maturity CDS.
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