Skip to content

FRM Part II · FRM Exam Part II · Derivatives

An investor buys a credit-linked note (CLN) issued by a bank, referencing a corporate borrower. Which statement best describes the investor's exposure?

The investor bears credit risk on both the reference entity and the issuing bank. The note embeds a sold CDS, so a credit event reduces repayment, and the investor also relies on the issuer to pay coupons and principal, so issuer default is a further loss source.

  1. AThe investor is exposed to both the reference entity's credit event and the issuing bank's default riskCorrect
  2. BThe investor is exposed only to the reference entity, since the note is fully funded
  3. CThe investor is exposed only to the issuer, since the reference entity is irrelevant
  4. DThe investor is protected against all losses via the note's principal guarantee

Explanation

A CLN embeds a CDS: the investor effectively sells protection on the reference entity and also holds the issuer's note, so it bears the credit risk of both. A fully funded structure removes counterparty exposure on the CDS only to the extent the issuer is solvent, so the issuer risk remains.

Did you get it right without looking?

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

Practise DerivativesFree diagnostic mock

More Derivatives questions