Financial Risk Manager Part 1

Explanation

J.P. Morgan Chase Bank's synthetic credit portfolio (SCP) was essentially a collection of credit default swaps that were part of standardized credit default swap indices. The bank assumed both buyer and seller positions in these swaps.

Key Points:

• As a protection buyer (holding a short risk position), the bank would pay premiums and receive compensation guarantees in case of default
• As a protection seller (holding a long risk position), the bank would receive premiums and promise to compensate buyers if defaults occurred
• This strategy allowed the bank to hedge against adverse credit scenarios, such as widening credit spreads, which were significant concerns during the 2007/2009 financial crisis

Why other options are incorrect:

• Choice A: Call options on S&P 500 stocks are equity derivatives, not credit instruments
• Choice C: Oil futures positions are commodity derivatives unrelated to credit risk
• Choice D: Mortgage-backed securities are actual securities, not synthetic representations of credit exposure