Credit Default Swaps – Q Bank
Set 1 Questions
1. In a CDS contract, the party that agrees to make a series of fixed periodic payments to the
counterparty over the contract term in return for a promise to be compensated by the
counterparty in case of default is best known as: A. the credit protection buyer.
B. the credit protection seller.
C. an option seller.
2. An advantage of an index CDS is that it permits investors to take positions on: A. the credit
risk of a particular bond issuer.
B. ETFs.
C. the credit risk of a combination of borrowers.
3. KLD Corp. issues bonds with a credit spread of 700 bps. A 10-year CDS against these bonds
bears an annual coupon rate of 5%. Which of the following statements is least likely correct?
A. The protection buyer agrees to make annual payments of 5% over the life of the CDS.
B. The protection seller promises to make annual payments amounting to 5% over the life
of the contract.
C. The protection buyer will make an upfront payment to the protection seller because the
standard rate is lower than the CDS credit spread.
4. The three main types of credit events are:
A. bankruptcy, voluntary restructuring, issuance of equity.
B. IPO, liquidation, litigation.
C. bankruptcy, involuntary restructuring, failure to pay.
5. A company files for bankruptcy, triggering CDS contracts. It has two series of senior bonds
outstanding: Bond P, which is trading at 40% of par, and Bond Q, which is trading at 50% of
par. The recovery rate for both CDS contracts is closest to: A. 50%.
B. 40%.
C. 60%
6. The most common settlement method for CDS following a credit event declaration is: A.
cash settlement.
B. physical settlement.
C. bond delivery.
7. Consider fa fcompany fwith fa fconstant fhazard frate fof f3% fper fquarter. fAn finvestor fsells f5-
year fCDS fprotection fon fthe fcompany fwith fpayments fmade fquarterly fover fthe flife fof fthe
fCDS fcontract. fThe fconditional fprobability fof fsurvival ffor fthe fsecond fquarter, fand fthe
fprobability fof fdefault f(sometime) fduring fthe ffirst ftwo fquarters fare fclosest fto:
fConditional fprobability f Probability fof fdefault f
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, Credit Default Swaps – Q Bank
of fsurvival ffor f2nd fquarter f during ffirst ftwo fquarters f
A. 3%. f f f f 97%. f f f f f f
B. 97%. f f f f 6%. f f
C. 94%. f f f f 12%. f f f f f
f
8. The fupfront fpayment fat fthe fstart fof fthe fCDS fcontract fis fpaid fby fthe fprotection fbuyer fto
fthe fprotection fseller fif: f
A. the fupfront fpayment fis fless fthan fzero. f
B. value fof fpremium fleg fis fgreater fthan fthe fvalue fof fprotection fleg. f
C. the fpresent fvalue fof fprotection fleg fis fgreater fthan fpresent fvalue fof fpremium fleg. f f
f
9. An fupward-sloping fcredit fcurve fmost flikely findicates: fA. fa fgreater fpossibility fof fdefault
fin flater fyears. f
B. a fgreater fpossibility fof fdefault fin fearlier fyears. f f
C. that fthe fprobability fof fdefault fwill fremain funchanged fthrough ftime. f
f
10. A fcompany’s f10-year fCDS ftrades fat fa fcredit fspread fof f600 fbps, fand fthe f5-year fCDS
ftrades fat fa fcredit fspread fof f350 fbps. fSuppose fthe f10-year fspread fwidens fby f120 fbps,
fwhereas fthe fcredit fspread fof fthe f5-year fCDS fremains funchanged. fThe fchange fin fthe
fcredit fcurve fsuggests fthat: f
A. the fcompany’s flonger-term fcreditworthiness fhas fimproved. f
B. the fcompany’s flonger-term fcreditworthiness fhas fdeteriorated. f f
C. the fcompany fhas fbecome friskier fthan fbefore fin fthe fshort fterm. f
f
11. Consider ftwo fsports fcar fmanufacturers, fAlpine fand fDelfino. fThe fcredit fquality fof fAlpine
fis fexpected fto fimprove fover fthe fnext fquarter fand fthat fof fDelfino fis fanticipated fto
fweaken fover fthe fsame ftime fperiod. fAn finvestor fcan fbenefit ffrom fthis fscenario fby: fA.
fgoing fshort fboth fAlpine fand fDelfino fCDS fcontracts. f f
B. going fshort fan fAlpine fCDS fand flong fa fDelfino fCDS. fC. fgoing flong fan fAlpine fCDS
fand fshort fa fDelfino fCDS. f
f f
12. Angela fowns fsome fbonds fissued fby fAlcarta fCorp. fShe fhas fbecome fconcerned fabout fa
fdefault fin fthe flong-run fbut fis fnot fworried fabout fdefault fin fthe fshort-term. fAlcarta’s ftwo-
year fCDS ftrades fat f300 fbps, fand fthe ffive-year fCDS ftrades fat f500 fbps. fWhich fof fthe
ffollowing fcurve ftrades fwould fbest fhedge fher frisk? f
A. Going fshort f(buying fprotection) fin fthe ffive-year fCDS, fand fgoing flong f(selling
fprotection) fin fthe ftwo-year fCDS. f f
B. Going flong f(selling fprotection) fin fthe ffive-year fCDS, fand fgoing fshort f(buying
fprotection) fin fthe ftwo-year fCDS. f
C. Going fshort fin fthe ffive-year fCDS, fwhile ftaking fno fposition fin fthe ftwo-year fCDS. f
f
f
f
f f
Set f1 fSolutions
f
Copyright © IFT. All rights reserved. Page 2
Set 1 Questions
1. In a CDS contract, the party that agrees to make a series of fixed periodic payments to the
counterparty over the contract term in return for a promise to be compensated by the
counterparty in case of default is best known as: A. the credit protection buyer.
B. the credit protection seller.
C. an option seller.
2. An advantage of an index CDS is that it permits investors to take positions on: A. the credit
risk of a particular bond issuer.
B. ETFs.
C. the credit risk of a combination of borrowers.
3. KLD Corp. issues bonds with a credit spread of 700 bps. A 10-year CDS against these bonds
bears an annual coupon rate of 5%. Which of the following statements is least likely correct?
A. The protection buyer agrees to make annual payments of 5% over the life of the CDS.
B. The protection seller promises to make annual payments amounting to 5% over the life
of the contract.
C. The protection buyer will make an upfront payment to the protection seller because the
standard rate is lower than the CDS credit spread.
4. The three main types of credit events are:
A. bankruptcy, voluntary restructuring, issuance of equity.
B. IPO, liquidation, litigation.
C. bankruptcy, involuntary restructuring, failure to pay.
5. A company files for bankruptcy, triggering CDS contracts. It has two series of senior bonds
outstanding: Bond P, which is trading at 40% of par, and Bond Q, which is trading at 50% of
par. The recovery rate for both CDS contracts is closest to: A. 50%.
B. 40%.
C. 60%
6. The most common settlement method for CDS following a credit event declaration is: A.
cash settlement.
B. physical settlement.
C. bond delivery.
7. Consider fa fcompany fwith fa fconstant fhazard frate fof f3% fper fquarter. fAn finvestor fsells f5-
year fCDS fprotection fon fthe fcompany fwith fpayments fmade fquarterly fover fthe flife fof fthe
fCDS fcontract. fThe fconditional fprobability fof fsurvival ffor fthe fsecond fquarter, fand fthe
fprobability fof fdefault f(sometime) fduring fthe ffirst ftwo fquarters fare fclosest fto:
fConditional fprobability f Probability fof fdefault f
Copyright © IFT. All rights reserved. Page 1
, Credit Default Swaps – Q Bank
of fsurvival ffor f2nd fquarter f during ffirst ftwo fquarters f
A. 3%. f f f f 97%. f f f f f f
B. 97%. f f f f 6%. f f
C. 94%. f f f f 12%. f f f f f
f
8. The fupfront fpayment fat fthe fstart fof fthe fCDS fcontract fis fpaid fby fthe fprotection fbuyer fto
fthe fprotection fseller fif: f
A. the fupfront fpayment fis fless fthan fzero. f
B. value fof fpremium fleg fis fgreater fthan fthe fvalue fof fprotection fleg. f
C. the fpresent fvalue fof fprotection fleg fis fgreater fthan fpresent fvalue fof fpremium fleg. f f
f
9. An fupward-sloping fcredit fcurve fmost flikely findicates: fA. fa fgreater fpossibility fof fdefault
fin flater fyears. f
B. a fgreater fpossibility fof fdefault fin fearlier fyears. f f
C. that fthe fprobability fof fdefault fwill fremain funchanged fthrough ftime. f
f
10. A fcompany’s f10-year fCDS ftrades fat fa fcredit fspread fof f600 fbps, fand fthe f5-year fCDS
ftrades fat fa fcredit fspread fof f350 fbps. fSuppose fthe f10-year fspread fwidens fby f120 fbps,
fwhereas fthe fcredit fspread fof fthe f5-year fCDS fremains funchanged. fThe fchange fin fthe
fcredit fcurve fsuggests fthat: f
A. the fcompany’s flonger-term fcreditworthiness fhas fimproved. f
B. the fcompany’s flonger-term fcreditworthiness fhas fdeteriorated. f f
C. the fcompany fhas fbecome friskier fthan fbefore fin fthe fshort fterm. f
f
11. Consider ftwo fsports fcar fmanufacturers, fAlpine fand fDelfino. fThe fcredit fquality fof fAlpine
fis fexpected fto fimprove fover fthe fnext fquarter fand fthat fof fDelfino fis fanticipated fto
fweaken fover fthe fsame ftime fperiod. fAn finvestor fcan fbenefit ffrom fthis fscenario fby: fA.
fgoing fshort fboth fAlpine fand fDelfino fCDS fcontracts. f f
B. going fshort fan fAlpine fCDS fand flong fa fDelfino fCDS. fC. fgoing flong fan fAlpine fCDS
fand fshort fa fDelfino fCDS. f
f f
12. Angela fowns fsome fbonds fissued fby fAlcarta fCorp. fShe fhas fbecome fconcerned fabout fa
fdefault fin fthe flong-run fbut fis fnot fworried fabout fdefault fin fthe fshort-term. fAlcarta’s ftwo-
year fCDS ftrades fat f300 fbps, fand fthe ffive-year fCDS ftrades fat f500 fbps. fWhich fof fthe
ffollowing fcurve ftrades fwould fbest fhedge fher frisk? f
A. Going fshort f(buying fprotection) fin fthe ffive-year fCDS, fand fgoing flong f(selling
fprotection) fin fthe ftwo-year fCDS. f f
B. Going flong f(selling fprotection) fin fthe ffive-year fCDS, fand fgoing fshort f(buying
fprotection) fin fthe ftwo-year fCDS. f
C. Going fshort fin fthe ffive-year fCDS, fwhile ftaking fno fposition fin fthe ftwo-year fCDS. f
f
f
f
f f
Set f1 fSolutions
f
Copyright © IFT. All rights reserved. Page 2
