RSK4805
ASSIGNMENT 2 2025
UNIQUE NO. 865771
DUE DATE: 30 AUGUST 2025
, RSK4804 Assignment 2 - 2025 Student Name: [Insert Name] Student Number:
[Insert Number] Due Date: 30 August 2025 Unique Number: 865771
Question 1 [10]
a. Why are credit default swaps (CDS) necessary? (2) Credit default swaps are
financial derivative instruments that allow investors to hedge against or speculate on the
credit risk of a borrower. They are necessary because they provide insurance against
the default of a debt instrument, transferring credit risk from one party to another. This
increases market liquidity and enables financial institutions to manage credit exposure
more effectively.
b. Why are some investors not in favour of credit default swaps? (2) Some
investors are not in favour of credit default swaps because they can lead to systemic
risks and speculative behaviour. CDSs were partly blamed for exacerbating the 2008
financial crisis due to lack of transparency, counterparty risk, and their use by parties
who had no direct interest in the underlying asset, often referred to as "naked CDSs."
c. Magong Rural Investments – CDS Default and No Default Scenarios (6)
Default Scenario: If Moepi Minerals Exploration defaults on its bond obligations
within the three-year period, Sedibelo Development Bank (the CDS seller) is
obliged to compensate Magong Platinum Project for the loss incurred (i.e., R80
million or the recovery amount, depending on the CDS agreement). Magong
Rural Investments thus transfers the credit risk to Sedibelo.
No Default Scenario: If Moepi Minerals Exploration does not default, Magong
Platinum Project will continue to pay an annual premium of 2.5% (R2 million per
year) to Sedibelo Development Bank over three years, totalling R6 million,
without receiving any payment in return. This is the cost of credit protection.
ASSIGNMENT 2 2025
UNIQUE NO. 865771
DUE DATE: 30 AUGUST 2025
, RSK4804 Assignment 2 - 2025 Student Name: [Insert Name] Student Number:
[Insert Number] Due Date: 30 August 2025 Unique Number: 865771
Question 1 [10]
a. Why are credit default swaps (CDS) necessary? (2) Credit default swaps are
financial derivative instruments that allow investors to hedge against or speculate on the
credit risk of a borrower. They are necessary because they provide insurance against
the default of a debt instrument, transferring credit risk from one party to another. This
increases market liquidity and enables financial institutions to manage credit exposure
more effectively.
b. Why are some investors not in favour of credit default swaps? (2) Some
investors are not in favour of credit default swaps because they can lead to systemic
risks and speculative behaviour. CDSs were partly blamed for exacerbating the 2008
financial crisis due to lack of transparency, counterparty risk, and their use by parties
who had no direct interest in the underlying asset, often referred to as "naked CDSs."
c. Magong Rural Investments – CDS Default and No Default Scenarios (6)
Default Scenario: If Moepi Minerals Exploration defaults on its bond obligations
within the three-year period, Sedibelo Development Bank (the CDS seller) is
obliged to compensate Magong Platinum Project for the loss incurred (i.e., R80
million or the recovery amount, depending on the CDS agreement). Magong
Rural Investments thus transfers the credit risk to Sedibelo.
No Default Scenario: If Moepi Minerals Exploration does not default, Magong
Platinum Project will continue to pay an annual premium of 2.5% (R2 million per
year) to Sedibelo Development Bank over three years, totalling R6 million,
without receiving any payment in return. This is the cost of credit protection.
