Beatrice Maestre Case scenario

Do corporate bonds not have counterparty credit risk?

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From my understanding, he might be talking about using Futures and Options against Swaps and Forwards given that futures and options are exchange traded and swaps and forwards are rather OTC.

Can’t be model risk as model risk is the risk of your assumptions in your model going haywire.

Spread risk is the risk arising out of widening of credit spreads which is not what they are getting at. Usually this would relate to HY bonds.

I know but ‘‘Maestre names a risk that is not faced in managing the portfolio’’ clearly refers to the defined pension plan portfolio.

In this case he’s not talking about bond issuers defaulting. If that was the case he would have just used treasury bonds to immunize his folio. The other half of his statement is “eliminated through the type of derivatives”, hinting at the use of exchange traded derivatives. Using forwards would lead to either one of the party defaulting as the contract is all in the air.

The question may be poorly worded.

It asks about any risk that can be “virtually eliminated” ie becomes 0.

The PM manages a pension fund., she would have to use swaps as derivative overlay to manage the liability (typical fixed income type) durations.

Only swaps can be reversed ie., if you own a reciever swap - turn around and buy a payor swap with the same counterparty and reverse your position. This equates to 0 counter party credit risk.

Please let me know of alternative view points