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Basic Question 5 of 5
There are two series of outstanding senior bonds issued by a company, which has filed for bankruptcy. Bond A trades at 20% of par, and Bond B trades at 30% of par. Investor X owns $10 million of bond A and investor Y owns $10 million of bond B. They both own $10 million of CDS protection.
B. cash settlement.
C. no preference. Either one would yield the same result.
Which settlement method would investor Y prefer?
A. physical settlement.
B. cash settlement.
C. no preference. Either one would yield the same result.
User Contributed Comments 6
| User | Comment |
|---|---|
| davcer | Cheapest to deliver obligation |
| Rivermax | Why would Y receive $8mn and not $7mn given he owns bond B? |
| dada | @Rivermax: Bond A is the cheapest to deliver obligation, so the recovery rate for both CDS protection is 20%. So Y will get 8 million on his CDS contract, plus 3 million to sell Bond B. |
| Truesilver | Why would bonds issued by the same company(=same credit risk) trade differently? |
| Rva100 | @Truesilver bonds can have different seniority, so if bond B is senior, the holders of this bond will be paid first. That makes bond B more valuable. |
| CFAJ | can't investor Y just acquire bond a and settle with that also making both equivalent. isn't that literally the whole idea behind cheapest to delive |
I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
Barnes
Learning Outcome Statements
describe credit events and settlement protocols with respect to CDS;
CFA® 2025 Level II Curriculum, Volume 4, Module 30.