Chapter 23 Credit Derivatives

1)
Suppose that the cumulative probability of a company defaulting by years one,
two, three and four are 3%, 6.5%, 10%, and 14.5%, respectively. What is the
probability of default in the fourth year conditional on no earlier default?
A)
4.5%
B)
5.0%
C)
5.5%
D)
6.0%

2)
What is the number of companies underlying the CDX NA IG index?
A)
50
B)
75
C)
100
D)
125

3)
What is the number of companies underlying the iTraxx index?
A)
50
B)
75
C)
100
D)
125

4)
What is the rating of the companies underlying the iTraxx index?
A)
A or above
B)
BBB or above
C)
BB or below
D)
BBB or below

5)
In a CDS with a notional principal of $100 million the reference entity
defaults. What is the payoff to the buyer of protection when the recovery rate
is 30%?
A)
$100 million
B)
$30 million
C)
$130 million
D)
$70 million

6)
In a one-year forward contract on a CDS that will last five years, what usually
happens if there is a default during the first year?
A)
There is a payoff to the forward protection buyer at the time of default
B)
There is a payoff to the forward protection buyer at the end of one year
C)
There is a payoff to the forward protection buyer at the end of six years
D)
The contract ceases to exist
7)
Which of the following is usually used to define the recovery rate of a bond?
A)
The value of the bond immediately after default as a percent of its face value
B)
The value of the bond immediately after default as a percent of the sum of the
bond’s face value and accrued interest
C)
The amount finally realized by a bondholder as a percent of face value
D)
The amount finally realized by a bondholder as a percent of the sum of the
bond’s face value and accrued interest

8)
Which of the following is true?
A)
Risk neutral default probabilities are usually much lower than real world
default probabilities
B)
Risk neutral default probabilities are usually much higher than real world
default probabilities
C)
Risk neutral and real world probabilities must be close to each other if there
are to be no arbitrage opportunities
D)
Risk-neutral default probabilities cannot be calculated from CDS spreads
9)
Which of the following happens when the default correlation of the companies
underlying a CDO increases?
A)
The value of the senior tranche and the equity tranche to the protection buyer
both increase
B)
The value of the senior tranche and the equity tranche to the protection buyer
both decrease
C)
The value of the senior tranche to the protection buyer decreases and the value
of the equity tranche to the protection buyer increases
D)
The value of the senior tranche to the protection buyer increases and the value
of the equity tranche to the protection buyer decreases

10)
Which of the following is true of a synthetic CDO?
A)
It is created from portfolios of bonds
B)
It is created from portfolios of CDSs
C)
It references a standard portfolio of bonds
D)
None of the above

11)
A CDS with a number of reference entities provides a payoff when any of the
reference entities defaults. What is a name for this CDS?
A)
Binary CDS
B)
Add-up Basket CDS
C)
First-to-Default CDS
D)
n-to-Default CDS

12)
Which of the following is the most popular life for a credit default swap?
A)
1 year
B)
3 years
C)
5 years
D)
10 years
13)
A hazard rate is 1% per annum. What is the probability of a default during the
first two years?
A)
2.00%
B)
2.02%
C)
1.98%
D)
1.96%

14)
If the CDS spread for a regular 5-year CDS is 120 basis points, what is the CDS
spread for a 5-year binary CDS on the same underlying reference entity? Assume
a recovery rate of 40%.
A)
48 basis points
B)
72 basis points
C)
200 basis points
D)
300 basis points

15)
For what range of losses is the equity tranche of iTraxx (or CDX NA IG)
responsible?
A)
0 to 10%
B)
0 to 7%
C)
0 to 6%
D)
0 to 3%

16)
Which of the following is true about a CDS?
A)
Restructuring is never a credit event
B)
Restructuring is always a credit event
C)
Certain types of restructuring qualify as credit events but others do not
D)
Sometimes a CDS is defined so that restructuring is a credit event and
sometimes it is not

17)
If the CDS-bond basis is X minus Y, what are X and Y?
A)
X is the CDS spread and Y is the excess of the bond yield over the swap rate
B)
X is the excess of the bond yield over the swap rate and Y is the CDS spread
C)
X is the CDS spread and Y is the excess of the bond yield over the Treasury
rate
D)
X is the excess of the bond yield over the Treasury rate and Y is the CDS
spread

18)
In the Lehman bankruptcy the payoff to people who had bought CDS protection was
91.375% of the notional principal. How was this determined?
A)
By calculation of the cheapest-to-deliver bond
B)
By an auction process
C)
By a calculation agent
D)
By Lehman’s liquidators
19)
Which of the following best describes a total return swap?
A)
It exchanges the realized return on an asset, including both income and capital
gains/losses, for a return, equal to LIBOR plus a spread on the initial value
of the asset
B)
It exchanges the promised return on an asset, including both income and capital
gains/losses, for a return equal to LIBOR plus a spread on the initial value of
the asset
C)
It exchanges the realized return on an asset, including income but not capital
gains/losses, for a return equal to LIBOR plus a spread on the initial value of
the asset
D)
It exchanges the promised return on an asset, including income but not capital
gains/losses, for a return equal to LIBOR plus a spread on the initial value of
the asset

20)
If a tranche spread is 55 basis points and the fixed coupon is 60 basis points,
which of the following happens when a trader buys protection?
A)
The trader pays an estimate of the present value of 5 basis points per year and
then pays 55 basis points per year
B)
The trader pays an estimate of the present value of 5 basis points per year and
then pays 60 basis points per year
C)
The trader receives an estimate of the present value of 5 basis points per year
and then pays 55 basis points per year
D)
The trader receives an estimate of the present value of 5 basis points per year
and then pays 60 basis points per year