Derivatives Foundation interview preparation

Questions

100

Traced to a firm

29

Firms

19

Updated

September 2026

Asked at

All firmsMSMorgan Stanley4Nomura4Akuna Capital2Amundi2HSBC2PIMCO2Bank of America1Barclays1Citadel1DRW1Goldman Sachs1Jane Street1Millennium Management1Mizuho1Old Mission Capital1RCRBC Capital Markets1Scotiabank1UBS1Wells Fargo Securities1

Topic

All topicsForwards and futures10Options basics8Option pricing7The Greeks10Volatility7Option strategies9Swaps and rates7Credit derivatives4Market structure and clearing6Indian derivatives8Trading and markets9Brainteasers6Fit9

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Type

AnyTechnicalCaseMarket viewBrainteaserFit

1. 059Explain how a credit default swap works.Credit derivativesIntermediatetechnicalCredit tradingRisk management

   Say this

   It is insurance on a borrower. The buyer pays a periodic spread on a notional; if a defined credit event happens, the seller makes them whole on the loss. Buying protection is economically short the credit, and you can do it without owning the bond, which is what makes CDS a trading instrument rather than just a hedge.

   Then walk it

   1. Cash flows: the protection buyer pays a running spread quarterly — say 150 basis points a year on 10 million, so 37,500 a quarter — until maturity or a credit event.
   2. On a credit event, settlement is now almost always by auction. The market determines a recovery price for the reference obligation and the protection seller pays notional times one minus recovery in cash. Physical delivery was the old convention and it broke when notional outstanding exceeded the deliverable bonds.
   3. What counts as a credit event is contractual, not intuitive: bankruptcy, failure to pay, and for some entities restructuring. A Determinations Committee at ISDA rules on it, and the rulings have been contested — the Greek restructuring and several cases of manufactured defaults are why the definitions were tightened in 2014 and again on narrowly tailored credit events.
   4. Uses: a bank hedges a loan book without selling the loans and damaging the client relationship; a fund expresses a negative view where the bonds are impossible to borrow; an investor buys a bond and sells protection to create synthetic exposure where no cash bond exists at that maturity.
   5. Index CDS matters more than single name now. CDX and iTraxx are standardised baskets that trade with far more liquidity than individual names, and they are how most macro credit risk is expressed and hedged.
   6. The limitations to name. It is a bilateral contract, so you are exposed to the seller — the 2008 lesson, where protection bought from AIG was worth what AIG was worth. And jump-to-default risk means the mark moves smoothly and the payoff does not, which is exactly the risk profile that looks harmless in a value-at-risk model right up until it isn't.

   Where candidates lose it

   Describing CDS as a bond short and stopping. Get the auction settlement and the contractual definition of a credit event in, because that is where the real disputes and losses happen. And name counterparty risk on the protection seller — the buyer is only hedged if the seller survives.

   Expect next

   • Who decides whether a credit event occurred?
   • Why did the market move from physical to auction settlement?
   • How is buying index protection different from shorting a basket of bonds?

Firm tags come from public, anonymous candidate reports on Wall Street Oasis: strong signal, not sworn testimony. Firms are named as the places a question was reported, not as partners of Fin Maverick. Answers are written for this page to show how to think out loud; they are not scripts to recite.