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Answer: CDS allow the bank to offset its exposure to the company with loan exposures to other manufacturing companies.
Credit Default Swaps (CDS) are credit derivatives that allow banks to transfer credit risk. Option D correctly describes how CDS can be used to offset exposure to a specific company by creating a position that pays off if that company defaults. This effectively hedges the bank's loan exposure. - Option A is incorrect because CDS don't directly quantify default risk or provide real-time monitoring - they are insurance-like contracts. - Option B is incorrect because CDS don't involve periodic revaluation of loans. - Option C is incorrect because CDS don't require early loan repayment.
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An analyst considers the use of different credit risk transfer mechanisms, including CDS, to manage this exposure. Which of the following statements correctly describes an appropriate benefit of using CDS in this situation?
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.