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Answer: Both the market for a country's bonds and the market for CDS on the country's bonds can be used as sources of data to derive a credit spread for the country.
C is correct. Both the CDS market and the market for the bonds issued by a country are sources of credit spread data. A is incorrect. One country with a given rating may have a lower credit spread (and therefore be perceived as less risky) than another country with the same rating because credit spreads are more granular than credit ratings. B is incorrect. Credit spreads are able to adjust more quickly to new information than ratings. However, they are also more volatile. D is incorrect. CDS only provides a payoff to the buyer if the reference entity defaults.
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A financial analyst employed by an asset management firm is evaluating the creditworthiness of bonds issued by various countries. The analyst's approach includes leveraging credit ratings from rating agencies and examining credit spreads to assess the credit risk associated with these sovereign bonds. Furthermore, the analyst is considering the use of sovereign credit default swaps (CDS) as a risk mitigation strategy. Among the options provided, what would be the correct conclusion for the analyst?
A
The bonds issued by two countries that have the same credit rating are highly likely to have the same credit spread
B
Sovereign credit ratings and corporate credit ratings adjust more quickly to new information about the borrower's creditworthiness than credit spreads do.
C
Both the market for a country's bonds and the market for CDS on the country's bonds can be used as sources of data to derive a credit spread for the country.
D
A sovereign CDS contract provides a payoff to the long position if a default or a credit migration of the reference entity occurs.