This question is about credit derivatives

1) Illustrate the framework Credit Default Swap (CDS).

2) Bank A makes a USD 10 million five-year loan and wants to offset the credit exposure to the obligor. A five-year credit default swap (CDS) with the loan as the reference asset trades on the market at a swap premium of 50 basis points (annual rate) paid quarterly. In order to hedge its credit exposure, what should bank A do? (Detail the payment if bank A uses CDS).

3) Illustrate the framework of total return swaps

4) Helman Bank has made a loan of USD 300 million at 7% per annum. Helman enters into a total return swap under which it will pay the interest on the loan plus the change in the marked-to-market value of the loan, and in exchange Helman will receive LIBOR + 50 basis points. Settlement payments are made annually. What is the cash flow for Helman on the first settlement date if the mark-to-market value of the loan falls by 2% and LIBOR is 4%?

5) Discuss the difference between Credit Default Swap and Total Return Swap in terms of hedging credit risk and market risk

		Standard	Normal		Distribution
n	1	1.25	1.65	2	2.33	2.55
Prob(X	84%	90%	95%	97.5%	99%	99.5%