# Good Comparison for Credit Risk of Swap....

#12, Schweser , SS14 pg 111 This question has it PV of Forward price - PV of Spot Price to figure out who has credit risk CFAI Text V5 pg 255 ex#1 They have PV of Spot - PV of Forward to figure out the credit risk I’m trying to figure out what is the key here of remembering which one to do when faced with a particular question ?

thought it wa s PV of Inflows - PV of Outflows Inflows is usually how much u will get paid the forward price usually

I would also like to know. Schweser has PV of inflows - PV of outlaws.

I don’t understand these at all and always just use: S/(1+i rate foreign) - F/(1+i rate domestic) which could explain why I’ll be back here next year

for that formula I think they played around with the s[(1+r dc)/(1+r fc)] while comparing it to the forward rate. but just remember the formula imo

F = S * (1+r_dc) / (1+r_fc). Divide by both sides you get F/(1+r_dc) = S/(1+r_fc). These should be equal, or stated another way, F/(1+r_dc) - S/(1+r_fc) = 0. If it’s not zero, you have credit risk (direction of sign determines who bears the sign).

I think I MIGHT have figured out the difference, and If you have schweser and the text boks I suggest you look at the 2 examples since this is my 3rd time I can tell you this has shown up on each of the last 2 exams. First break down general logic: You have positive value if you ( the PM) is going to * PAY * for something down the road( Forward) that is LESS than current price ( i.e SPOT). So If I pay for something thats going to cost me \$1 in 1 month for something currently worth \$3, i’m doing good, and this is positive to me, hence potential credit risk is with counterparty and of course within the next month, this could change therefore we dont say there is any current credit risk since we have not yet reached settlement date. The other way we can think about this and I think is the main difference between the 2 examples I originally posted above is you can think of the PM who will * RECEIVE* something. You obviously want to RECEIVE something in future ( Forward) that is worth MORE than the current price ( Spot). And even though both examples were long forwards, one was a PM who was Borroing forward currency, and the other one was paying hence the difference. I just have to remember which one to discount at the foreign rate vs the domestic rate. ** Guys, allot of these MC questions can be done without even knowing the calculations just the theory, or at minimum will allow you to delete the 1 wrong question int he MC which will leave you with a 50/50 chance for the remaining 2 if you forgot the formula

3rdtimesacharm? Wrote: ------------------------------------------------------- > #12, Schweser , SS14 pg 111 > > This question has it PV of Forward price - PV of > Spot Price to figure out who has credit risk Manager is entering into a Short forward contract. > > CFAI Text V5 pg 255 ex#1 > > They have PV of Spot - PV of Forward to figure out > the credit risk Manager is entering into a Long forward contract. I don’t completely understand the logic behind it but that is the only difference between 2 questions. CFAI asked this question last year … similar to Text V5 pg 255 ex#1 I used PV Forward - PV Spot … wrong answer … zero point as this will change the direction of credit risk. Hope this helps

Rakesh, If we combine your statement: " Manager is entering into a Short forward contract" Then which one of my explanation’s below makes sense? You have positive value if you ( the PM) is going to * PAY * for something down the road( Forward) that is LESS than current price ( i.e SPOT). So If I pay for something thats going to cost me \$1 in 1 month for something currently worth \$3, i’m doing good, and this is positive to me, hence potential credit risk is with counterparty and of course within the next month, this could change therefore we dont say there is any current credit risk since we have not yet reached settlement date. The other way we can think about this and I think is the main difference between the 2 examples I originally posted above is you can think of the PM who will * RECEIVE* something. You obviously want to RECEIVE something in future ( Forward) that is worth MORE than the current price ( Spot).

3rdtimesacharm In your first statement if you are in profit (PV of inflows>PV of outflows) then you are exposed to potential cr risk & not counterparty because this profit/current value is claimable if counterparty defaults.

FOR CREDIT RISK IN A FORWARD CONTRACT: First convert any rate CFAI gives you in DC/FC, they could trick by giving FC/DC. 1. If you are long a forward contract: Sell spot discount at foreign rate - Buy forward discount at domestic rate 2. If you are short a forward contract: Sell forward discount at domestic rate - Buy spot discount at foreign rate If value is negative, you need to pay --> other side bears credit risk The key is to remember forward always discount at domestic rate and spot always discount at foreign rate which comes from here: F = S (1+Rd)/(1+Rf) or F/(1+Rd) - S /(1+Rf)=0 After all of this, I can almost bet they give us credit risk of swap for 2010 exam.

that was great inbead…thanks for posting

Guys a way simpler method is to simply recalculate the new forward price that would take place on the market with F= s( 1+rd / 1 + rl)^T Then you just substract this foward price to the one which the mgt entered and pv the result. This will give you the credit risk of the forward. J.

I just used the above formula to resolve 2009, 2008 and CFAI text problems. It works every single time. The key is to remember to convert into DC/FC.