Skip to content

FRM Part I · FRM Exam Part I · Measuring Credit Risk

A bank buys credit protection through a credit default swap on a bond it holds. After a credit event, the bond trades at 35% of par and the CDS is physically settled. Which describes the bank's position correctly?

The bank delivers the defaulted bond and receives par from the protection seller. This transfers the credit loss, leaving only the premiums paid and any basis or documentation mismatch risk. Receiving 65% while keeping the bond describes cash settlement, not physical delivery.

  1. AIt delivers the bond and receives par, so its net loss is limited to the protection cost and basis riskCorrect
  2. BIt receives 35% of par and keeps the bond
  3. CIt receives par but also keeps the bond
  4. DIt receives 65% of par and keeps the bond

Explanation

In physical settlement the protection buyer delivers the defaulted bond and receives par. The credit loss is thereby transferred to the seller. The bank still bears the premiums paid and any mismatch risk. Cash settlement would pay 65% of par while the bank kept the bond.

Did you get it right without looking?

One question tells you little. A timed set on Measuring Credit Risk shows your real accuracy, how long you take and where you lose marks.

Practise Measuring Credit RiskFree diagnostic mock

More Measuring Credit Risk questions