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Answer: Credit derivatives can help to price the credit spread risk for a wide variety of financial instruments that have credit risk exposure.
## Explanation **C is correct.** Credit derivatives can help in price discovery and quantification of the credit spread risk for a wide variety of financial instruments with credit risk exposure, including privately traded high-yield loans and loan portfolios. **A is incorrect.** The credit spread is the difference in the yield on instruments subject to credit risk (e.g., bonds, derivatives, and loans) and comparable maturity Treasury bonds, not the difference between actual and expected rates of return. **B is incorrect.** In a mature credit market, credit risk (not market risk) extends beyond default risk to include credit spread risk. Also, model risk is classified as an operational risk, not market risk. **D is incorrect.** The credit spread is the difference in the yield on instruments subject to credit risk (e.g., bonds, derivatives, and loans) and comparable maturity Treasury bonds. Bonds are liquid assets, not illiquid assets.
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A risk analyst at a trading firm is evaluating different approaches to mitigate the risks of a portfolio. The analyst assesses the characteristics of credit spreads and focuses on credit spread risk. Which of the following statements is correct?
A
The credit spread is equal to the difference between the actual rate of return of a risky financial instrument and the expected rate of return of that instrument.
B
In a mature financial market, a portfolio's market risk typically includes credit spread risk, interest rate risk, and model risk.
C
Credit derivatives can help to price the credit spread risk for a wide variety of financial instruments that have credit risk exposure.
D
Financial instruments that have credit spread risk are typically illiquid assets.
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