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FRM Part II · FRM Exam Part II · Credit Derivatives

A bank buys five-year credit protection on a corporate reference entity through a single-name CDS. Which event describes the protection buyer's obligation under a standard contract before any credit event occurs?

The protection buyer pays the periodic CDS spread on the notional until maturity or a credit event. Delivery of bonds occurs only after a credit event, and no full notional is paid upfront, so the premium stream is the buyer's ongoing obligation.

  1. APay the periodic premium (spread) on the notional until maturity or a credit eventCorrect
  2. BDeliver the reference obligation to the protection seller at inception
  3. CPost the full notional amount as an upfront payment to the seller
  4. DPay the seller the expected loss at maturity only if default occurs

Explanation

The protection buyer pays a periodic premium, typically quarterly, on the notional until the contract matures or a credit event occurs. Delivery of bonds happens only after a credit event under physical settlement. Paying the full notional upfront is not part of the contract.

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