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FRM Part I · FRM Exam Part I · Swaps

A currency swap requires exchange of principal at both inception and maturity, whereas an interest rate swap typically exchanges only net interest payments. Which is the most accurate consequence for credit risk?

Currency swaps typically carry more credit risk than interest rate swaps. The final exchange of full principal in two currencies, combined with exchange rate movements, can create a large positive value for one party, whereas interest rate swaps net only the difference in interest payments.

  1. ACurrency swaps usually carry greater credit risk because the final exchange of principal in different currencies can create a large exposure if exchange rates moveCorrect
  2. BInterest rate swaps carry greater credit risk because they involve larger notional amounts
  3. CBoth swap types have identical credit risk because the notional is the same
  4. DCurrency swaps have no credit risk because principal amounts are exchanged simultaneously

Explanation

In a currency swap the final principal exchange exposes a party to exchange rate moves on the full principal, and the value can become substantially positive. Interest rate swaps net only coupon differences, so exposure is smaller. Simultaneous exchange does not eliminate counterparty default risk during the life of the swap.

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