CFA Practice Question

There are 252 practice questions for this study session.

CFA Practice Question

There are two series of outstanding senior bonds issued by a company, which has filed for bankruptcy. Bond A trades at 20% of par, and Bond B trades at 30% of par. Investor X owns $10 million of bond A and investor Y owns $10 million of bond B. They both own $10 million of CDS protection.

Which settlement method would investor Y prefer?

A. physical settlement.
B. cash settlement.
C. no preference. Either one would yield the same result.
Correct Answer: B

Physical settlement: Y would deliver $10 million Bond B for $10 million cash.

Cash settlement: Y would receive $8 million, and sell Bond B for $3 million. Total proceeds: $8 + $3 = $11 million.

User Contributed Comments 6

User Comment
davcer Cheapest to deliver obligation
Rivermax Why would Y receive $8mn and not $7mn given he owns bond B?
dada @Rivermax: Bond A is the cheapest to deliver obligation, so the recovery rate for both CDS protection is 20%. So Y will get 8 million on his CDS contract, plus 3 million to sell Bond B.
Truesilver Why would bonds issued by the same company(=same credit risk) trade differently?
Rva100 @Truesilver bonds can have different seniority, so if bond B is senior, the holders of this bond will be paid first. That makes bond B more valuable.
CFAJ can't investor Y just acquire bond a and settle with that also making both equivalent. isn't that literally the whole idea behind cheapest to delive
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