The Following Information Relates to Questions
John Smith, a Fixed-Income

question 2

Multiple Choice

The following information relates to Questions
John Smith, a fixed-income portfolio manager at a €10 billion sovereign wealth fund(Swf) , meets with Sofia Chan, a derivatives strategist with Shire Gate Securities (SGS) ,to discuss investment opportunities for the fund. Chan notes that SGS adheres to iSda(international Swaps and derivatives association) protocols for credit default swap (CdS) transactions and that any contract must conform to iSda specifications. before the
fund can engage in trading CdS products with SGS, the fund must satisfy compliance requirements.
Smith explains to Chan that fixed-income derivatives strategies are being contemplated
for both hedging and trading purposes. Given the size and diversified nature of the fund,
Smith asks Chan to recommend a type of CdS that would allow the Swf to simultaneously
fully hedge multiple fixed-income exposures.
Next, Smith asks Chan to assess the impact on derivative products of recent events affect-ing Maxx Corporation, a uS company. The Swf holds an unsecured debt instrument issued by Maxx. Chan says she is very familiar with Maxx because many of its unsecured debt obliga-tions are commonly included in broad baskets of bonds used for hedging purposes. SGS recently sold €400 million of protection on the on-the-run CdX high yield (hY) index that includes aMaxx bond; the index contains 100 entities. Chan reports that
creditors met with company executives to impose a restructuring on Maxx bonds; as a result,all outstanding principal obligations will be reduced by 30%.Smith and Chan discuss opportunities to add trading profits to the Swf. Smith asks Chan
to determine the probability of default associated with a five-year investment-grade bond issued
by orion industrial. Selected data on the orion industrial bond are presented in exhibit 1.eXhibit 1 Selected data on orion industrial five-Year bond
$$\begin{array} { l c } \text { Year } & \text { Hazard Rate } \\\hline 1 & 0.22 \% \\2 & 0.35 \% \\3 & 0.50 \% \\4 & 0.65 \% \\5 & 0.80 \% \\\hline\end{array}$$
Chan explains that a single-name CdS can also be used to add profit to the fund over time. Chan describes a hypothetical trade in which the fund sells £6 million of five-year CdS protection on orion, where the CdS contract has a duration of 3.9 years. Chan assumes that the fund closes the position six months later, after orion's credit spread narrowed from 150 bps to 100 bps.
Chan discusses the mechanics of a long/short trade. in order to structure a number of potential trades, Chan and Smith exchange their respective views on individual companies and global economies. Chan and Smith agree on the following outlooks.
Outlook 1: italy's economy will weaken.
Outlook 2: The uS economy will strengthen relative to that of Canada.
Outlook 3: The credit quality of electric car manufacturers will improve relative to that of
traditional car manufacturers.
Chan believes uS macroeconomic data are improving and that the general economy will
strengthen in the short term. Chan suggests that a curve trade could be used by the fund to capitalize on her short-term view of a steepening of the uS credit curve.another short-term trading opportunity that Smith and Chan discuss involves the merger and acquisition market. SGS believes that delta Corporation may make an unsolicited bid at a premium to the market price for all publicly traded shares of Zega, inc. Zega's market cap-italization and capital structure are comparable to delta's; both firms are highly levered. it is anticipated that delta will issue new equity along with 5- and 10-year senior unsecured debt to fund the acquisition, which will significantly increase its debt ratio.
-following the Maxx restructuring, the CdX hY notional will be closest to:

• A) €396.0 million.
• B) €398.8 million.
• C) $400.0 million.

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Definitions:

Coronal

Pertaining to the plane dividing the body into anterior and posterior portions, also referred to as the frontal plane.

Deviated Septum

A condition where the nasal septum, the bone and cartilage dividing the nasal cavity, is off-center or crooked, often causing breathing difficulties.

Vomer Bone

A thin, flat bone forming part of the nasal septum, which divides the left and right airways in the nose.

Ethmoid Bone

A sponge-like bone located at the roof of the nasal cavity and forming part of the orbits of the eyes.