Why is the credit risk for an interest rate swap the highest in the middle of the swap and not at the beginning ? Aren’t there more number of int. payments to be netted and potentailly defalulted upon when you are at the beginning of the swap than when you are at the midde of the swap?
At the middle between settlement dates would be the highest credit risk I believe
trymybest Wrote: ------------------------------------------------------- > Why is the credit risk for an interest rate swap > the highest in the middle of the swap and not at > the beginning ? > > Aren’t there more number of int. payments to be > netted and potentailly defalulted upon when you > are at the beginning of the swap than when you are > at the midde of the swap? At the beginning, the value of the swap is 0 for both sides. so no credit risk. As time passes and with the rates moving, one party starts owing to the other party. however, the passage of time also means there are less payments remaining which means lesser credit risk. Therefore, the highest credit risk must be somewhere in the middle.
he knows that, he’s asking why that is Someone refresh my memory please…
Ah yes… I could remember the part about the rates changing and the credit risk developing as the swap gets further into it’s term but forgot about the # of payments remaining… Good post.
also, one exception is a currency swap, where the risk is highest between middle of the settlement dates and increases once you approach settlement the reason being for it is when the swap was initiated, parties exchanged currencies, and both parties bear the risk that one of them will default and you don’t get your original currency and will be stuck with a foreign currency
also, parties usually do dd, that is why risk is minimal at the initation of IR swap and it maximizes by mid-term as time passes and there is still significant amount of cashflow outstanding