1. Why do swaps have significant credit risk? 2. How does the credit risk on swaps...

1. Why do swaps have significant credit risk?

2. How does the credit risk on swaps differ from the credit risk on loans?

3. Describe a situation in which it would be beneficial for two financial institutions to enter into a currency swap with each other.

Solutions

Expert Solution

1) Swaps have significant credit risk as it is an agreement of exchange of cash flows at a future time period. The credit risk is high as there is no guarantee that the other party will make the payment on time.

2) The difference between credit risk on loans and swaps is that the risk in loans is about the payment of the loan amount and in case of swaps is that of the interest rate at which the swap has been agreed upon.

3) An example of swap contract is when the financial institutions of two countries have decided to exchange the cash flows on a future date at a given interest rate. The financial institution of France and US may agree to exchange cash flows at LIBOR Rate. This will be the swap contract between the two financial institutions.

jeff jeffy answered 1 year ago

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