CDS Question - Buy Protection

CFA Level II Fixed Income
#1

Hi All!

I have noticed in all CFAI mock exams and practice tests the following…

Buy protection = Buy CDS.

For example “Company X issues debt to acquire Company Y. Solution: Buy a CDS, because you need to buy protection due to high risk”

However book (official) says Buy protection = SELL CDS.

This makes me mad. I have lost so many questions due to this. Finally, which answer is right? Buy protection is buy or sell CDS? I can’t believe that CFAI theory (and EOC questions) claim the opposite to the CFAI mocks.

Please help!!!

#2

Never seen this before in the book. Which page is that?

Buy protection = Buy CDS (Short)

#3

399 - 400 (examples, if you have the 2020 book)

However you can see this also on the EOC exercises.

For example, US credit curve steepens. In the short term credit spreads fall (macroeconomic data are improving in the short term). How to take advantage of this situation? The answer is go long the 2y CDX (sell protection because spreads fall) and short the long term CDX (buy protection).

Another example, X acquires Y with debt. Which strategy is the best? Due to high risk you should long Y shares and simultaneously short CDS (buy protection) on X’s debt.

All these in official book.

On the other hand in mock exams,
Company X acquires Y with 100% debt. Best strategy? Buy CDS on X’s debt because “X’s credit fundamentals to deteriorate”.

I really don’t get it. In all mock exams I had in CDS exercises 2/6 score because I do what the book says.

#4

That’s odd. Page 399-400 is Reading 38 (Derivatives) in my book.

But, anyway, if you refer to Reading 36 (Credit Default Swaps), Page 282, Section 2.2 Important Features of CDS Markets and Instruments and go right to the very end of the section, and in the last paragraph you should see:

Hence, the CDS industry views the credit protection seller as the long and the buyer as the short. This point can lead to confusion because we effectively say the credit protection buyer is short and the credit protection seller is long.

Buy protection = buy CDS = short position in CDS

Sell protection = sell CDS = long position in CDS

#5

If I pass…I will make you a statue!

Thanks a lot!

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