Explain why the position of a buyer of a credit default swap is similar to the...

Explain why the position of a buyer of a credit default swap is similar to the position of someone who is long a risk-free bond and short a corporate bond.

Expert Solution

Answer:

Credit default swap- It is a derivative contract that allows investor to swap his/her credit risk with other investor. It is used to transfer the credit risk between two or more parties. In this buyer of the swap pays to seller of the swap until the maturity date of contract.

Risk free bonds- These are the Government securities that do not have risk and pay a fixed amount of coupon/interest to bondholders. They repay the principal on time.

Corporate bonds- These bonds are issued by companies to raise the funds. They pay fixed amount of interest but they are risky bonds.

The position of a buyer of a credit default swap is similar to the position of someone who is long a risk-free bond and short a corporate bond- Credit default swap insures a corporate bond, issued by the company against default. CDS mitigates the risk by converting corporate bonds into risk free bonds. Buyer of a CDS chooses to exchange a corporate bond for a risk free bond that is why the buyer is long with a risk free bond and short with a corporate bond.

jeff jeffy answered 7 months ago

What is a credit default swap (CDS)? What “credit events” might trigger a payout? Explain how...

What is a credit default swap (CDS)? What “credit events” might trigger a payout? Explain how the CDS market influenced the crisis of 2007-2009.

Explain the concept of Credit Default Swap (“CDS”), how it evolved over time and the role...

Explain the concept of Credit Default Swap (“CDS”), how it evolved over time and the role it played in the 2007-08 financial crisis. (1500 words)

Could you describe and explain how Michael Burry using the credit default swap in "The Big...

Could you describe and explain how Michael Burry using the credit default swap in "The Big Short" film to profit from the collapsing house market? What is the underlying asset of credit default swap in "The Big Short" film? Why Michael Burry and the others sell the credit default swap to close their position before the maturity date? Why they don’t wait until maturity to receive a payoff if they are sure most mortgage contracts will be default triggered by...

Choose one derivative product: credit default swap, interest rate swap, currency swap, forwards, futures or any...

Choose one derivative product: credit default swap, interest rate swap, currency swap, forwards, futures or any other derivative security you found interesting. definition of the instrument, simple explanation how the instrument works, as well as description of potential investor`s profiles (i.e who and why usually buy the instrument)

Which of the following is true about a credit default swap? A. All three of these...

Which of the following is true about a credit default swap? A. All three of these potential answers here are true about a credit default swap. B. It is basically the same as a mortgage backed security C. It is insurance on an investment D. It helps to reduce the defualt rate on mortgages

B) (i)Explain the mechanics of a standard credit default swap (CDS) using a diagram. (5 marks)...

B) (i)Explain the mechanics of a standard credit default swap (CDS) using a diagram. ii) Evaluate why CDS markets provide an important barometer of the creditworthiness of corporate bond markets.

32-34.) You are asked to value a credit default swap on a bond with a $1,000,000...

32-34.) You are asked to value a credit default swap on a bond with a $1,000,000 face value. In the event of default, the bond is expected to have a recovery rate of 60%. The probability of default is 10%. You will be purchasing 3 years of protection. The Treasury STRIP rates are as follows: Maturity STRIP Rate 1 4% 2 6% 3 8% What is the cost of the credit default swap?

This question is about credit derivatives 1) Illustrate the framework Credit Default Swap (CDS). 2) Bank...

This question is about credit derivatives 1) Illustrate the framework Credit Default Swap (CDS). 2) Bank A makes a USD 10 million five-year loan and wants to offset the credit exposure to the obligor. A five-year credit default swap (CDS) with the loan as the reference asset trades on the market at a swap premium of 50 basis points (annual rate) paid quarterly. In order to hedge its credit exposure, what should bank A do? (Detail the payment if bank...

Assume that you are lending money to company X. A credit default swap (CDS) consists of...

Assume that you are lending money to company X. A credit default swap (CDS) consists of an agreement by a third party to pay the lost principal and interest of a loan to you (the CDS buyer) if a borrower defaults on a loan. Which of the following is false? A. A Swap completely solves the problem that company X might default B. A Swap solves the default problem from Company X on the condition that the third party (CDS...

QUESTION 16 Which credit derivative has proven to be most successful one? a. Credit-default swap. b....

QUESTION 16 Which credit derivative has proven to be most successful one? a. Credit-default swap. b. Credit spread option. c. Credit-linked note.

Question