Kalton Corporation has two large derivatives positions with a London securities house. The first position is a long forward currency contract to buy pounds at 1.4500. The current exchange rate is 1.4000 per pound. The second position is a long put position on the DJ Euro STOXX Index with a strike price of 305.00. The current closing price of the index is 295.00. A Kalton manager raised the following question to the risk management committee (RMC), I am concerned about the risks of these two large positions. Who is bearing the credit risks, Kalton Corporation or the counterparty (the London securities house)? the RMC replies: Kalton Corporation is bearing the credit risk of the currency forward contract, but the London securities house is bearing the credit risk of the put option on the DJ Euro STOXX Index.

Because they believe that the credit risk in corporate bonds is going to decline, Kalton Corporation managers have decided to increase Kaltons credit risk exposure in corporate bonds. They have asked the risk management committee to recommend derivatives positions to accomplish this change.

QUESTION (a) Regarding Kaltons two derivatives position, is RMC correct about which party is bearing the credit risk of the currency forward contract and the put option on the DJ Euro STOXX Index, respectively?

Currency Forward Contract

A. No B. No C. Yes

D. Yes

Put Option

No

Yes

Yes

No

QUESTION (b) To make the desired change in Kaltons credit risk exposure in corporate bonds, the RMC could recommend that Kalton take a position as a

A Seller in a credit default swap

B Buyer in a credit default swap

C Buyer of a put option on a corporate bond

D None of the answers