int rate swap & credit risk

CFA Level II
#1

The credit risk of an interest-rate swap is greatest: A) just before the final payment must be made. B) at the middle of the term. C) late in the term. Your answer: B was correct! can someone explain why?

#2

Begin: credit risk is small, since neither party would engage in the swap if there is significant credit risk identified. Middle: credit risk is at its highest, because credit quality can have deteriorated and there are significant future payments remaining on the swap. End: credit risk is low, since there are few payments left. In currency swaps, principal is exchanged at termination of the swap so the period of higher credit risk is a little later in the swap’s life.

#3

maybe one more note on this - remember that the party to which the swap has a negative value is not subject to credit risk

#4

so the credit risk in the middle is really an assumption of exposure to credit risk rather than actual credit deterioration?

#5

Credit risk does not imply credit deterioration, it is simply the risk or possibility of credit deterioration.

#6

Middle risk- due to the fact that most of the payments are still due. At the begnning this is not the case, due to the assumption that the swap was correctly priced to account for the credit risk of the counterparty. At the end there are not many payments left to be received (therefore low).

#7

ok thanks

#8

in the case of forward… at any poing in time it can be positive, negative or even change sign… in a futures there is none of course since you have the clearinghouse

#9

When the credit risk of an currency swap swap is greatest? begining, middle or end of the term?

#10

Currency swap-end of term…due to exchange of notional

#11

What about current credit risk (specifically Question 52 in Mock PM)? So there is no current credit risk at initiation? but there is general credit risk? Can someone pls explain this to me? or am I reading this wrong?

#12

anyone notice this as well?

#13

I think they mean there is not current credit risk because no payment is exchanging hands at that stage… overall the postition still has risk that will be present at some point but not at initiation