Pension Funds and Credit Risk Concepts

The video explains the role of pension funds in lending money and the constraints they face due to credit ratings. It introduces credit default swaps as a solution for pension funds to invest in lower-rated bonds by insuring them through companies like AIG. The video discusses the mechanics of credit default swaps, the role of ratings agencies like Moody's, and the potential risks involved in AIG's business model of insuring debts without setting aside collateral.

Why do pension funds prefer to lend money rather than keep it idle?

• To support government projects

• To avoid paying taxes

• To increase their asset value

• To earn interest

What is a key restriction for pension funds when investing?

• They can only invest in foreign markets

• They can only invest in highly rated securities

• They must invest in real estate

• They must invest in technology stocks

Who typically provides credit ratings for corporations?

• Non-profit organizations

• Private entities like Moody's

• International banks

• Government agencies

What is the main purpose of a credit default swap?

• To extend the loan term

• To reduce the loan amount

• To insure loans against default

• To increase the interest rate on loans

What is a basis point in financial terms?

• 10% of a percentage

• 1/100th of 1%

• 1% of a percentage

• 1/10th of 1%

How does AIG benefit from insuring loans?

• By earning insurance premiums

• By setting aside collateral

• By reducing their credit rating

• By increasing their debt

What happens if a corporation defaults on a loan insured by AIG?

• The loan is forgiven

• AIG pays back the loan amount

• The pension fund loses its investment

• The corporation is sued

What is the effective interest rate for a pension fund using a CDS?

• The full interest rate from the corporation

• The interest rate divided by the insurance premium

• The interest rate minus the insurance premium

• The interest rate plus the insurance premium

What is a potential risk of AIG's business model?

• They might run out of clients

• They could face a downgrade in credit rating

• They might have too much collateral

• They could earn too much profit

Why might Moody's not lower AIG's credit rating despite high risk?

• AIG has too many assets

• Moody's is a government agency

• Moody's is paid by AIG

• AIG has no debt