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FRM Part I · FRM Exam Part I · Credit Risk Transfer Mechanisms

Which feature distinguishes a funded credit risk transfer from an unfunded one?

A funded transfer requires the protection seller to pay cash upfront, as with a credit-linked note. This collateralizes the obligation so the protection buyer faces little counterparty risk, whereas an unfunded transfer like a standard CDS depends on the seller's future ability to pay.

  1. AIn a funded transfer, the protection seller invests cash upfront, as with a credit-linked note, reducing counterparty risk to the buyerCorrect
  2. BIn a funded transfer, the protection buyer pays all premiums upfront and bears the default loss
  3. CA funded transfer always involves transfer of legal title of the loan
  4. DA funded transfer cannot reference a single entity

Explanation

In a credit-linked note the investor pays the principal upfront, which collateralizes the protection and removes the buyer's exposure to seller default. A plain CDS is unfunded, relying on the seller's promise to pay. Funded structures need not transfer legal title and can reference single names.

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