RSK4804
Assignment 2 | Due
30 August 2025
NO PLAGIARISM
[Pick the date]
[Type the company name]
,Exam (elaborations)
RSK4804 Assignment 2 | Due 30 August 2025
• Course
• Credit Risk Management (RSK4804)
• Institution
• University Of South Africa (Unisa)
• Book
• Credit Risk Management
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) b. Why are some investors not in favour of credit default swaps? (2) c.
Magong Rural Investments has invested R80m in bonds issued by Moepi Minerals
Exploration. Magong Rural Investments has noted that Moepi Minerals Exploration may
be experiencing financial difficulties. Therefore, Magong Platinum Project buys R80 m
worth of CDS protection on Moepi Minerals Exploration debt, for three years, from the
Sedibelo Development Bank, at a premium of 250 bps (2.5%) per annum. Explain the
scenarios of default and no default. (6)
a. Why are credit default swaps (CDS) necessary? (2 marks)
Credit default swaps are necessary because they provide a way for investors to manage and
transfer credit risk. They act like insurance against the default of a borrower. Investors use CDS
to:
• Hedge their exposure to credit risk in bonds or loans.
• Speculate on the creditworthiness of companies or countries without owning the
underlying debt.
b. Why are some investors not in favour of credit default swaps? (2 marks)
Some investors are not in favour of CDS because:
• Speculative use: CDS can be used to bet against companies or countries, potentially
destabilizing markets.
, • Lack of transparency: Before regulatory reforms, CDS markets were largely
unregulated and opaque, which contributed to the 2008 financial crisis.
• Systemic risk: A large CDS payout from a counterparty default (e.g., Lehman Brothers
or AIG) can have a domino effect on the financial system.
c. Scenario explanation: Magong Platinum Project buys CDS protection (6
marks)
Background:
• Magong Rural Investments owns R80 million in Moepi Minerals bonds.
• Concerned about default, they buy CDS protection for R80 million from Sedibelo
Development Bank.
• Premium: 250 bps (2.5%) annually for 3 years.
Scenario 1: No default occurs
• Moepi Minerals continues to meet its debt obligations.
• Magong Platinum Project pays R2 million annually (2.5% of R80 million) to Sedibelo
for 3 years.
• Total premiums paid over 3 years: R6 million.
• No payout is triggered. This functions like an insurance premium with no claim.
Scenario 2: Default occurs
• If Moepi Minerals defaults on its debt within the 3-year term:
o Sedibelo Development Bank is obligated to compensate Magong Platinum
Project.
o Typically, Sedibelo would pay the loss amount (difference between face value
and recovery value of the bond).
o Example: If the recovery value is 40%, Sedibelo pays 60% of R80 million = R48
million.
o Magong Platinum Project stops paying further premiums after the default.
a. Why are credit default swaps (CDS) necessary?
Assignment 2 | Due
30 August 2025
NO PLAGIARISM
[Pick the date]
[Type the company name]
,Exam (elaborations)
RSK4804 Assignment 2 | Due 30 August 2025
• Course
• Credit Risk Management (RSK4804)
• Institution
• University Of South Africa (Unisa)
• Book
• Credit Risk Management
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) b. Why are some investors not in favour of credit default swaps? (2) c.
Magong Rural Investments has invested R80m in bonds issued by Moepi Minerals
Exploration. Magong Rural Investments has noted that Moepi Minerals Exploration may
be experiencing financial difficulties. Therefore, Magong Platinum Project buys R80 m
worth of CDS protection on Moepi Minerals Exploration debt, for three years, from the
Sedibelo Development Bank, at a premium of 250 bps (2.5%) per annum. Explain the
scenarios of default and no default. (6)
a. Why are credit default swaps (CDS) necessary? (2 marks)
Credit default swaps are necessary because they provide a way for investors to manage and
transfer credit risk. They act like insurance against the default of a borrower. Investors use CDS
to:
• Hedge their exposure to credit risk in bonds or loans.
• Speculate on the creditworthiness of companies or countries without owning the
underlying debt.
b. Why are some investors not in favour of credit default swaps? (2 marks)
Some investors are not in favour of CDS because:
• Speculative use: CDS can be used to bet against companies or countries, potentially
destabilizing markets.
, • Lack of transparency: Before regulatory reforms, CDS markets were largely
unregulated and opaque, which contributed to the 2008 financial crisis.
• Systemic risk: A large CDS payout from a counterparty default (e.g., Lehman Brothers
or AIG) can have a domino effect on the financial system.
c. Scenario explanation: Magong Platinum Project buys CDS protection (6
marks)
Background:
• Magong Rural Investments owns R80 million in Moepi Minerals bonds.
• Concerned about default, they buy CDS protection for R80 million from Sedibelo
Development Bank.
• Premium: 250 bps (2.5%) annually for 3 years.
Scenario 1: No default occurs
• Moepi Minerals continues to meet its debt obligations.
• Magong Platinum Project pays R2 million annually (2.5% of R80 million) to Sedibelo
for 3 years.
• Total premiums paid over 3 years: R6 million.
• No payout is triggered. This functions like an insurance premium with no claim.
Scenario 2: Default occurs
• If Moepi Minerals defaults on its debt within the 3-year term:
o Sedibelo Development Bank is obligated to compensate Magong Platinum
Project.
o Typically, Sedibelo would pay the loss amount (difference between face value
and recovery value of the bond).
o Example: If the recovery value is 40%, Sedibelo pays 60% of R80 million = R48
million.
o Magong Platinum Project stops paying further premiums after the default.
a. Why are credit default swaps (CDS) necessary?
