Multiple Choice

1.1 A CDS is an instrument that provides insurance against default by a particular company. This company is known as

Reference entity

Cheapest to deliver bond

1.2 Risk-neutral probability of default:

a. Prices the credit default swap at its current value using the risk-free rate

b. Is lower than the physical probability of default

c. Both of the above

1.3Expectations hypothesis states that forward rate equals the expected future short rate. (True / False)

1.4The comparative advantage argument for the popularity of interest rate swaps is based on the assumption that poorly rated firms may be pushed to borrowing in the floating rate market while their first choice is fixed. (True / False)

1.5When value of a swap is negative to one of the parties, the other party faces credit risk. (True / False)