QUESTION 5. This question is about credit derivatives 5.1) The bank of HSBC 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 annually. In order to hedge its credit exposure, what should the bank do? (Detail the payment if the bank uses CDS). And discuss whether using CDS can entirely eliminate credit risk. (10 %) 5.2) Helman Bank has made a loan of USD 100 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 + 100 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 10% and LIBOR is 2%? (10 %) 5.3) llustrate the framework of Collateralized Debt Obligation (CDO) and discuss the extent to which the default correlation affects senior tranche of CDO. (13.3 %) (Total 33.3 %) QUESTION 5. This question is about credit derivatives 5.1) The bank of HSBC 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 annually. In order to hedge its credit exposure, what should the bank do? (Detail the payment if the bank uses CDS). And discuss whether using CDS can entirely eliminate credit risk. (10 %) 5.2) Helman Bank has made a loan of USD 100 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 + 100 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 10% and LIBOR is 2%? (10 %) 5.3) llustrate the framework of Collateralized Debt Obligation (CDO) and discuss the extent to which the default correlation affects senior tranche of CDO. (13.3 %) (Total 33.3 %)