Question

Which statement regarding pure credit swaps and total return swaps is incorrect?

a. The total return swap includes an element of interest rate risk.

b. The pure credit swap has stripped interest rate risk from the contract

c. The pure credit swap is not tied to interest rate changes

d. In the total return swap, the lender makes a fixed fee or payment premium to the counterparty in exchange for the potential coverage of any loss due to a specific borrower defaulting on a loan

e. The pure credit swap is similar in payoff to a digital default option with the exception that the premium is paid over the life of the swap rather than at the initiation of the risk coverage as with the option

Answer 1

Statment (d)  In the total return swap, the lender makes a fixed fee or payment premium to the counterparty in exchange for the potential coverage of any loss due to a specific borrower defaulting on a loan is incorrect.

Total return swap is a contract in which one party pays on a rate ( fixed / flexible) while the other side makes payments on the basis of returns on the underlying asset. ( including the returns in form of dividends of capital appreciation)