,RSK4804 Assignment 2 (COMPLETE ANSWERS) 2025
(865771) - DUE 30 August 2025 ;100% TRUSTED
Complete, trusted solutions and explanations
Question 1 [10]
In recent years, there has been quite a buzz about credit default
swaps. The turn of events following the 2008 Global Financial
Crisis became a test of the systems that settle credit default swaps.
a. Why are credit default swaps (CDS) necessary? (2)
Credit default swaps are necessary because they allow investors
to hedge against the risk of default on debt instruments such
as corporate or government bonds. They provide a form of
credit insurance, enabling bondholders to transfer the risk of a
borrower's default to another party, usually a financial
institution, in exchange for a premium.
b. Why are some investors not in favour of credit default swaps?
(2)
Some investors are not in favour of CDS because:
1. Speculative use – CDS can be used for speculative
purposes by parties who do not actually own the underlying
, debt, which may distort market behaviour and increase
systemic risk.
2. Lack of transparency and regulation – The CDS market
has often operated with limited oversight, making it
difficult to assess counterparty risk and potentially
contributing to financial instability, as seen during the 2008
Global Financial Crisis.
c. Scenario: Magong Rural Investments & Moepi Minerals
Exploration (6)
Background:
Magong Rural Investments owns R80 million in Moepi
Minerals bonds.
Concerned about Moepi’s financial troubles, they buy R80
million worth of CDS protection from Sedibelo
Development Bank at a premium of 250 basis points
(2.5%) per year for three years.
i. If Moepi Minerals Exploration defaults:
Sedibelo Development Bank, as the CDS seller, is
obligated to compensate Magong Rural Investments for
the defaulted amount.
This means Sedibelo pays R80 million (or the loss amount
depending on the recovery rate of the bonds).
Magong Rural Investments is thus protected from the credit
loss, even though Moepi defaults.
(865771) - DUE 30 August 2025 ;100% TRUSTED
Complete, trusted solutions and explanations
Question 1 [10]
In recent years, there has been quite a buzz about credit default
swaps. The turn of events following the 2008 Global Financial
Crisis became a test of the systems that settle credit default swaps.
a. Why are credit default swaps (CDS) necessary? (2)
Credit default swaps are necessary because they allow investors
to hedge against the risk of default on debt instruments such
as corporate or government bonds. They provide a form of
credit insurance, enabling bondholders to transfer the risk of a
borrower's default to another party, usually a financial
institution, in exchange for a premium.
b. Why are some investors not in favour of credit default swaps?
(2)
Some investors are not in favour of CDS because:
1. Speculative use – CDS can be used for speculative
purposes by parties who do not actually own the underlying
, debt, which may distort market behaviour and increase
systemic risk.
2. Lack of transparency and regulation – The CDS market
has often operated with limited oversight, making it
difficult to assess counterparty risk and potentially
contributing to financial instability, as seen during the 2008
Global Financial Crisis.
c. Scenario: Magong Rural Investments & Moepi Minerals
Exploration (6)
Background:
Magong Rural Investments owns R80 million in Moepi
Minerals bonds.
Concerned about Moepi’s financial troubles, they buy R80
million worth of CDS protection from Sedibelo
Development Bank at a premium of 250 basis points
(2.5%) per year for three years.
i. If Moepi Minerals Exploration defaults:
Sedibelo Development Bank, as the CDS seller, is
obligated to compensate Magong Rural Investments for
the defaulted amount.
This means Sedibelo pays R80 million (or the loss amount
depending on the recovery rate of the bonds).
Magong Rural Investments is thus protected from the credit
loss, even though Moepi defaults.
