Credit exposure

rinky63a
Good Student
Posts: 15
Joined: Fri Jul 27, 2012 3:42 pm

Credit exposure

Postby rinky63a » Thu May 15, 2014 10:49 am

(1) For a 10 year, $100 million notional amount, which one of the following swap position has the highest potential future credit exposure at the time specified ?

(a) Currency swap 3 yrs after inception.
(b) Currency swap 5 yrs after inception.
(c) Interest rate swap 3 yrs after inception
(d) Interest rate swap 5 yrs after inception.

(2) In 10 yr of swap when is highest potential future credit exposure in interest rate swap.

Pls let me know correct answers for both questions with explanation.

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Credit exposure

Postby edupristine » Tue Jul 08, 2014 6:44 am

Hi rinky63a,
The correct answer is (b) ie currency swap 5 years after inception.

In case of an interest rate swap, we know that the notional amount is never exchanged in the beginning and at the end of the contract. So, the credit exposure is minimized (potential for losses reduces).

However, in the case of currency swap, notional amounts are exchanged both at the beginning and end of the contract. This increases the exposure of the counterparties (in case anyone defaults on notional payment etc).

Based upon the above reasoning, we can directly rule out options © and (d) involving interest rate swaps.

Now we are left with options (a) and (b).

The correct answer is (b) ie currency swap 5 years after inception. This is because in a currency swap, the greater the passage of time, the more is the exposure. The maximum exposure is towards the end of the transaction when its time to exchange the notionals.

Now out of options (a) and (b), option (b) is closer to maturity of the swap, hence the credit exposure is maximum at this point.

In 10 year swap, the highest potential future credit exposure is at 7 years.
Last edited by edupristine on Tue Jul 08, 2014 7:04 am, edited 1 time in total.

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Postby edupristine » Tue Jul 08, 2014 7:04 am

In 10 year swap, the highest potential future credit exposure is at 7 years.


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