Credit Risk in Bonds Involves Uncertainty About Whether the Bond

question 6

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 default risk will worsen, while not taking a view on recovery risk, you would most prefer to

• 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) Sell a credit default swap (CDS).
• D) Buy a digital default swap (DDS).

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Definitions:

Losses

Financial losses are considered for tax purposes as deductions from income earned, which can reduce taxable income and therefore tax liability.

AMT Purposes

Refers to calculations made to ensure that individuals pay a minimum amount of tax under the Alternative Minimum Tax system.

Active Participation

In tax terms, a level of involvement by a taxpayer in managing an investment property that qualifies them for certain tax benefits.

Rental Offset

A financial mechanism where rental income is used to offset or reduce mortgage payments, expenses, or other financial obligations related to the rental property.