Skip to content

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

Which feature distinguishes a funded credit risk transfer, such as a credit-linked note, from an unfunded one, such as a standard CDS?

In a funded structure like a credit-linked note, the investor pays principal upfront, so the protection buyer already holds the cash to cover a default loss. This largely removes counterparty risk, unlike an unfunded CDS that depends on the seller paying later.

  1. AThe protection buyer receives cash upfront from the investor, reducing counterparty risk on the protection sellerCorrect
  2. BThe protection buyer pays no premium in a funded structure
  3. CThe reference entity guarantees the note
  4. DFunded structures cannot be tied to a reference entity

Explanation

In a credit-linked note the investor pays the principal upfront, which collateralises the protection obligation, so the buyer faces little counterparty risk. An unfunded CDS relies on the seller's future promise to pay. Funded notes still reference an entity and still involve coupons or premium-equivalent spread.

Did you get it right without looking?

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

Practise Credit Risk Transfer MechanismsFree diagnostic mock

More Credit Risk Transfer Mechanisms questions