CFA Practice Question

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CFA Practice Question

Which statement is true?

A. There are there parties involved in a credit default swap: protection buyer, protection seller, and reference entity.
B. A CDS can be thought of as a put option on a bond.
C. The credit spread is always constant for the life of a CDS.
Correct Answer: B

A is false: The reference entity is not a party to the contract. Neither the buyer nor the seller needs to obtain its consent to enter into a CDS.
B is true: Protection buyer is protected from losses incurred by a decline in the value of the bond as a result of a credit event. A CDS resembkes an insurance policy.
C is false: the reference entity's credit quality may change later.

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