Explanation:
In trade compression, only contracts on the same reference credit can be compressed. Let's analyze the positions:
Reference Credit: NUMU Inc.
Reference Credit: WKL Company
Compression Process:
Result:
Why other options are incorrect:
Trade compression reduces counterparty risk by netting offsetting positions while maintaining the same market risk exposure, but only works for positions on the same reference credit.
Ultimate access to all questions.
The head of the structured securities desk at an investment bank directs all derivatives traders on the desk to use trade compressions on all eligible trades to reduce counterparty risk. One of the analysts decides to use trade compression on a portfolio of single-name CDS contracts with the same maturity and transacted with two counterparties, as presented in the table below, to estimate the investment bank's compressed notional value:
| Counterparty | Reference credit | Notional (EUR million) | Bank's position | Coupon (bps) |
|---|---|---|---|---|
| Digital Corporation | NUMU Inc. | 9 | Long protection | 180 |
| Digital Corporation | WKL Company | 6 | Long protection | 150 |
| WKL Company | NUMU Inc. | 7 | Short protection | 150 |
What is the notional value of the investment bank's net contract on compressed trades only?
A
EUR 1 million
B
EUR 2 million
C
EUR 8 million
D
EUR 15 million
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