RSK4804
Assignment 2
Unique N0: 865771
DUE: 30 August 2025
, ASSIGNMENT 02
Due date: 30 August 2025
Unique number 865771
Question 1
a. Why are credit default swaps (CDS) necessary? (2)
CDS are necessary because they allow investors to protect themselves against the risk
of a bond issuer defaulting on their debt. It works like insurance if the borrower fails to
pay, the investor gets compensated by the CDS seller. This helps manage credit risk in
the financial system.
b. Why are some investors not in favour of credit default swaps? (2)
Some investors dislike CDS because they can be used for speculation rather than
protection, which increases risk in the market. They also make it harder to assess who
really holds the risk, which contributed to the 2008 financial crisis.
c. Scenario involving Magong Rural Investments and Sedibelo Development Bank
(6)
Magong Rural Investments holds R80 million in bonds from Moepi Minerals, which is
showing signs of financial trouble. To protect against the risk of default, Magong
Platinum Project buys CDS protection worth R80 million from Sedibelo Development
Bank, paying a 2.5% annual premium for 3 years.
• If Moepi does not default:
Magong continues paying 2.5% of R80m (which is R2 million per year) to
Sedibelo for three years. In total, they pay R6 million and receive no payout. It's
the cost of protection like paying insurance without making a claim.
• If Moepi does default during the 3 years:
Sedibelo Development Bank must compensate Magong for the defaulted amount
(R80 million or the actual loss, depending on the CDS terms). Magong is
protected against losing their investment, minus the R2 million per year they paid
in premiums.
Assignment 2
Unique N0: 865771
DUE: 30 August 2025
, ASSIGNMENT 02
Due date: 30 August 2025
Unique number 865771
Question 1
a. Why are credit default swaps (CDS) necessary? (2)
CDS are necessary because they allow investors to protect themselves against the risk
of a bond issuer defaulting on their debt. It works like insurance if the borrower fails to
pay, the investor gets compensated by the CDS seller. This helps manage credit risk in
the financial system.
b. Why are some investors not in favour of credit default swaps? (2)
Some investors dislike CDS because they can be used for speculation rather than
protection, which increases risk in the market. They also make it harder to assess who
really holds the risk, which contributed to the 2008 financial crisis.
c. Scenario involving Magong Rural Investments and Sedibelo Development Bank
(6)
Magong Rural Investments holds R80 million in bonds from Moepi Minerals, which is
showing signs of financial trouble. To protect against the risk of default, Magong
Platinum Project buys CDS protection worth R80 million from Sedibelo Development
Bank, paying a 2.5% annual premium for 3 years.
• If Moepi does not default:
Magong continues paying 2.5% of R80m (which is R2 million per year) to
Sedibelo for three years. In total, they pay R6 million and receive no payout. It's
the cost of protection like paying insurance without making a claim.
• If Moepi does default during the 3 years:
Sedibelo Development Bank must compensate Magong for the defaulted amount
(R80 million or the actual loss, depending on the CDS terms). Magong is
protected against losing their investment, minus the R2 million per year they paid
in premiums.
