Credit Risk in Bonds Involves Uncertainty About Whether the Bond

question 21

Multiple Choice

Credit risk in bonds involves uncertainty about whether the bond will default (default risk) , and uncertainty about the value of the bonds when they default (recovery risk) . In order to profit from a view that recovery risk will worsen, you would

• A) Buy a credit default swap (CDS) and sell a digital default swap (DDS).
• B) Sell a credit default swap (CDS) and buy a digital default swap (DDS).
• C) Buy a credit default swap (CDS) and buy a digital default swap (DDS).
• D) Sell a credit default swap (CDS) and sell a digital default swap (DDS).

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Definitions:

Impaired Claimants

Individuals who have a claim (usually in a legal or bankruptcy context) but whose right to collect or settle is limited or reduced.

Indubitable Equivalent

A term in bankruptcy law referring to a replacement of collateral that is unquestionably equal in value to the original collateral.

Granted A Discharge

The release of a debtor from the obligation to repay his or her debts, typically occurring at the conclusion of a bankruptcy case.

Liquidation Proceeding

A legal process in which a company's assets are distributed to claimants, conducted when the company is insolvent and unable to meet its debt obligations.