CREDIT RISK MANAGEMENT

QUESTION AND ANSWER

Question 1 [30]

In recent years, there has been quite a buzz about credit default swaps. The turn of events following the 2008 Global Financial crisis became a test of the systems that settle credit default swaps.

1. Define credit default swaps (CDS) and why they are necessary. (8 Marks)

2. What are advantages and disadvantages of CDS? (10 Marks)

3. Walvis Corporation has invested R75m in bonds issued by Mashava Oil Exploration. Walvis is somehow worried that Mashava Oil Exploration may be facing a financial crisis. Therefore, Walvis buys R75m worth of CDS protection on Mashava Oil Exploration debt for two years from Gweru Investment Bank at a premium of 250 bps (2.5%) per annum. Explain scenarios of default and no default. (12 Marks)

*Please take ALL your time in researching the question, answer very accurately and in detail.*