RSK4804
ASSIGNMENT 2
DUE DATE: 30 AUGUST 2025
,RSK4804 Assignment 2 2025
DUE 30 AUGUST 2025
UNIQUE CODE: 865771
Question 1
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?
Credit default swaps provide a way for lenders or bond-holders to hedge the credit risk
of a single issuer by transferring the risk of default or other agreed “credit events” to a
protection seller in exchange for a periodic premium. Without CDS, institutions would
have to hold large capital buffers against every issuance, reducing liquidity and
increasing funding costs for both issuers and investors
(Swaps, “Credit Default Swaps,” p. 1). (Credit Rating and Probability of Default 165)
b. Why are some investors not in favour of credit default swaps?
Some investors criticise CDS because they can be used speculatively i.e. “naked” CDS
where the buyer holds no underlying exposure), which may amplify losses and create
moral-hazard incentives. Moreover, the over-the-counter nature of CDS contracts
introduces counterparty risk and “wrong-way” risk where the protection seller’s credit
, quality deteriorates under the same conditions that trigger CDS payouts potentially
destabilising the financial system (Study Notes on Credit Default Swaps,
“Wrong-Way Risk,” p. 2; “Naked CDS,” p. 3).
(318 Advanced Credit Risk Analysis and Management)
C. Magong Rural Investments / Magong Platinum Project CDS deal
Magong Platinum Project buys R 80 million of three-year CDS protection on Moepi
Minerals Exploration from Sedibelo Development Bank at an annual premium of 2.5%
(250 bps).
No‐default scenario
Premium payments -Project pays
0.025×R80000000= R2000000
Per year, for three years, totalling R 6 million in premiums.
Outcome: No credit event occurs - Sedibelo keeps the R 6 million; Magong Platinum
Project has no further pay-out.
Result: Protection seller gross profit = R 6 million; buyer’s “insurance” cost = R 6 million
(Study Notes on Credit Default Swaps, “No Default,” p. 1).
Default scenario
Moepi Minerals Exploration suffers a credit event (e.g. fails to pay), and the CDS is
triggered.
Under physical settlement, Magong Platinum Project delivers the defaulted bonds to
Sedibelo and receives par value (R 80 million).
Under cash settlement, Sedibelo pays the difference between par (R 80 million) and the
ASSIGNMENT 2
DUE DATE: 30 AUGUST 2025
,RSK4804 Assignment 2 2025
DUE 30 AUGUST 2025
UNIQUE CODE: 865771
Question 1
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?
Credit default swaps provide a way for lenders or bond-holders to hedge the credit risk
of a single issuer by transferring the risk of default or other agreed “credit events” to a
protection seller in exchange for a periodic premium. Without CDS, institutions would
have to hold large capital buffers against every issuance, reducing liquidity and
increasing funding costs for both issuers and investors
(Swaps, “Credit Default Swaps,” p. 1). (Credit Rating and Probability of Default 165)
b. Why are some investors not in favour of credit default swaps?
Some investors criticise CDS because they can be used speculatively i.e. “naked” CDS
where the buyer holds no underlying exposure), which may amplify losses and create
moral-hazard incentives. Moreover, the over-the-counter nature of CDS contracts
introduces counterparty risk and “wrong-way” risk where the protection seller’s credit
, quality deteriorates under the same conditions that trigger CDS payouts potentially
destabilising the financial system (Study Notes on Credit Default Swaps,
“Wrong-Way Risk,” p. 2; “Naked CDS,” p. 3).
(318 Advanced Credit Risk Analysis and Management)
C. Magong Rural Investments / Magong Platinum Project CDS deal
Magong Platinum Project buys R 80 million of three-year CDS protection on Moepi
Minerals Exploration from Sedibelo Development Bank at an annual premium of 2.5%
(250 bps).
No‐default scenario
Premium payments -Project pays
0.025×R80000000= R2000000
Per year, for three years, totalling R 6 million in premiums.
Outcome: No credit event occurs - Sedibelo keeps the R 6 million; Magong Platinum
Project has no further pay-out.
Result: Protection seller gross profit = R 6 million; buyer’s “insurance” cost = R 6 million
(Study Notes on Credit Default Swaps, “No Default,” p. 1).
Default scenario
Moepi Minerals Exploration suffers a credit event (e.g. fails to pay), and the CDS is
triggered.
Under physical settlement, Magong Platinum Project delivers the defaulted bonds to
Sedibelo and receives par value (R 80 million).
Under cash settlement, Sedibelo pays the difference between par (R 80 million) and the
