Answer-first summary for fast verification
Answer: CDS quantify the manufacturing company's default risk and allow the bank to monitor changes in this risk on a real-time basis.
The correct answer is A. Credit Default Swaps (CDS) are financial derivatives that allow a bank to transfer the credit risk of a loan or bond to a third party. In this case, the bank is concerned about a loan exposure to a large manufacturing company that is losing market share. By using a CDS, the bank can quantify the company's default risk and monitor changes in this risk on a real-time basis. This is an advantage over credit ratings, which only provide periodic updates on a company's default risk. CDS do not provide the features described in options B, C, and D, such as periodic revaluation of the loan, requiring the company to pay back the loan early, or offsetting exposure with other loan exposures. The use of CDS in this situation allows the bank to manage its credit risk more effectively and mitigate potential losses from the company's default.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
No comments yet.
A risk analyst at a financial institution is concerned about the bank’s loan exposure to a large industrial company, which is currently facing significant losses in its market share. The analyst is considering different credit risk mitigation strategies, including the use of credit default swaps (CDS). Which of the following statements correctly identifies a benefit of using CDS in this context?
A
CDS quantify the manufacturing company's default risk and allow the bank to monitor changes in this risk on a real-time basis.
B
CDS provide an agreement to periodically revalue the loan and transfer any net value change.
C
CDS require the manufacturing company to pay back the loan in full at an earlier point in time.
D
CDS allow the bank to offset its exposure to the company with loan exposures to other manufacturing companies.