Which of the following is correct regarding credit derivatives?

A) If the expected recovery value increases, then the size of payment upon the occurrence of a credit event will increase. This will increase the protection payment.
B) If the expected recovery value decreases, then the size of payment upon the occurrence of a credit event will decrease. This will increase the protection payment.
C) If the expected recovery value decreases, then the size of payment upon the occurrence of a credit event will remain stable. This will increase the protection payment.
D) If the expected recovery value decreases, then the size of payment upon the occurrence of a credit event will increase. This will increase the protection payment.

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Oscar Pante · Accepted Answer

Final Answer : D, Explanation :  The correct answer is D because in credit derivatives, if the expected recovery value decreases, it means that the loss given default is expected to be higher. Therefore, the size of the payment upon the occurrence of a credit event (such as default) will increase to cover the higher expected loss. This, in turn, increases the protection payment provided by the credit derivative.

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