FRM Part II · FRM Exam Part II · Credit Derivatives
A bank holds a portfolio of corporate loans and wants to transfer the credit risk of the portfolio to an investor while keeping the loans on its balance sheet and retaining the client relationships. Which structure best achieves this?
A synthetic CDO is the best choice. The bank buys credit protection through credit default swaps on the loan portfolio, transferring credit risk to investors while the loans stay on its balance sheet and the client relationships are kept. A cash CDO would require selling the loans.
- AA synthetic CDO in which the bank buys protection through credit default swaps referencing the loan portfolioCorrect
- BA cash CDO in which the loans are sold to a special purpose vehicle
- CAn interest rate swap exchanging fixed for floating payments
- DA total return swap in which the bank receives the return on a government bond index
Explanation
A synthetic CDO transfers credit risk through credit default swaps while the loans stay on the originator's balance sheet. A cash CDO requires the legal sale of the assets to an SPV, so the loans leave the balance sheet. The interest rate swap and the government bond index swap do not transfer the loans' credit risk.
Did you get it right without looking?
One question tells you little. A timed set on Credit Derivatives shows your real accuracy, how long you take and where you lose marks.
More Credit Derivatives questions
- A dealer prices a 5-year CDS on a corporate name with a standardised coupon of 100 bp. The par (market) spread for the name is 160 bp, and t…
- A CDS with USD 10 million notional is cash settled after a credit event. The final auction price of the cheapest-to-deliver bond is 35% of p…
- Bond yields for a risky 5-year bond are 6.0% and the risk-free 5-year rate is 4.5%, both on a comparable basis. A CDS on the same issuer tra…
- A bank buys CDS protection on a loan from a counterparty. The reference entity and the counterparty have independent defaults, with one-year…
- A risk analyst estimates that a reference entity has a constant annual hazard rate of 2% and an expected recovery rate of 40%. Using the cre…
- A five-year CDS has a quoted spread of 150 bps. Assume a constant hazard rate, a recovery rate of 40%, and the credit triangle approximation…