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Explanation:
The Add-up Basket CDS structure ensures payout on any individual default within the covered basket of sovereign debts, meeting the risk manager's criteria for a multi-entity coverage derivative with aggregate default triggers.
A is incorrect. Single-name CDS contracts address the credit risk of a singular reference entity only and, therefore, are not compatible with the risk manager's requirement to cover a basket of sovereign debts with multiple potential payouts.
B is incorrect. Total Return Swaps are concerned with exchanging total returns of assets but do not have built-in features directly tied to payouts on each default within a basket.
C is incorrect. Synthetic CDOs prioritize credit risk based on tranche seniority and are not structured to make payouts on each default specifically, making them mismatched for the manager's multi-default concerned credit derivative requirement.
Q.6063 In the quest to optimize their credit risk management practices, a risk manager at a financial institution is researching various credit derivatives suitable for a basket of sovereign debts. They prefer a financial instrument that triggers payouts if any of the included entities default. The solution must accommodate the possibility of multiple default events, each resulting in payouts. Which type of credit derivative would fulfill this requirement?
A
Single-name Credit Default Swap (CDS).
B
Total Return Swap (TRS).
C
Synthetic Collateralized Debt Obligation (CDO).
D
Add-up Basket CDS
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