Explanation:
The correct answer is B.
A holder of a CDS call option possesses the right, but not the obligation, to purchase credit protection at a predetermined strike spread at a specified future date. This option provides the holder with valuable flexibility in managing credit risk. If they foresee or anticipate credit deterioration in the market, they can exercise the call option to secure protection at the predetermined strike spread. This strategy enables them to capitalize on the perceived weakening of credit quality and protect their positions or portfolios against adverse credit events, effectively mitigating potential losses in the event of default by the reference entity. It's a risk management tool that allows for dynamic responses to changing credit conditions.
A is incorrect. Selling protection would be the right granted by a put option, not a call option.
C is incorrect. A total return swap arrangement is different from the right a CDS call option confers.
D is incorrect. Diversifying credit risk exposure across multiple entities would involve products like basket CDS, not call options on single-entity CDS.
Things to Remember.
Ultimate access to all questions.
No comments yet.
Q.6079 CDS options, like calls and puts, allow holders to either buy or sell protection at an agreed-upon spread at a future date. A CDS call option grants the buyer the right but not the obligation to become the protection buyer, potentially benefiting from worsening credit conditions, whereas a put option may be used to secure a selling position in anticipation of improving credit conditions. What does a holder of a CDS call option gain the right to do?
A
Sell protection at a predetermined spread, anticipating credit improvement.
B
Buy protection at a predetermined spread, catering to expected credit declines.
C
Enter into a total return swap at a fixed rate, reflecting a general economic view.
D
Engage in a basket of CDS contracts, diversifying credit risk exposure.