CFA Level I · CFA Level I Exam · Forward Commitment and Contingent Claim Features and Instruments
A credit default swap on a corporate bond is most likely to pay out the protection buyer following which of the following events?
A CDS pays out after a defined credit event, such as bankruptcy, failure to pay or restructuring. A missed interest payment after any grace period is a failure to pay and triggers settlement. A share price decline or negative rating outlook is not a contractual credit event.
- AThe reference entity's equity price falls by 40% in a month
- BThe reference entity fails to make a scheduled interest payment after any grace periodCorrect
- CThe reference entity's credit rating is placed on negative outlook
Explanation
Credit events defined in CDS contracts include bankruptcy, failure to pay and restructuring. A falling share price or a negative outlook does not trigger settlement, since neither is a defined credit event.
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