Credit Risk Management Practice Exam

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What is the purpose of using mark-to-market and spread volatility in measuring spread risk?

To estimate future profits from trades
To compute the CDS mark-to-market value
To analyze market liquidity
To forecast economic downturns

The correct answer is: To compute the CDS mark-to-market value

The purpose of using mark-to-market and spread volatility in measuring spread risk is fundamentally tied to the assessment of derivatives, particularly credit default swaps (CDS). By utilizing mark-to-market values, one can evaluate the current market value of a financial instrument based on its current market price rather than its book value. This approach reflects the real-time market conditions, allowing stakeholders to gauge the instrument's performance more accurately. Spread volatility, which refers to the fluctuations in the spread (the difference in yield between a risky asset and a risk-free asset), is instrumental in understanding how external factors influence the credit risk of a counterparty or instrument. When analyzing the CDS mark-to-market value, both of these elements help quantify potential losses or gains associated with changes in credit spreads and market sentiment. This analysis is crucial for risk management, as it informs strategies for hedging and addressing potential credit exposures. Thus, the combination of mark-to-market assessments and spread volatility serves to provide a nuanced understanding of the credit risk inherent in trading derivatives like CDS, making it a pivotal aspect of risk measurement in this context.