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FRM Part I · FRM Exam Part I · Swaps

Why does a fixed-for-fixed currency swap generally expose a counterparty to more credit risk than an otherwise comparable single-currency interest rate swap of the same notional and maturity?

Currency swaps carry larger credit exposure because the principals, denominated in different currencies, are re-exchanged at maturity. Exchange-rate movements can make that final exchange heavily favour one side, whereas an interest rate swap involves only net interest payments and no principal exchange.

  1. APrincipal in different currencies is re-exchanged at maturity, so exchange-rate moves can create a large exposure at the endCorrect
  2. BCurrency swaps always involve a floating leg, which raises the interest rate exposure
  3. CInterest payments in currency swaps are made in advance, which raises settlement risk
  4. DCurrency swaps are always transacted with exchanges rather than in OTC markets

Explanation

Because the final principals are in different currencies, a large exchange-rate move can leave one party owed far more value than it owes, and the exposure builds toward maturity. In an interest rate swap, principals are not exchanged and only net interest is at risk. Standard fixed-for-fixed currency swaps do not need a floating leg, and they are OTC contracts.

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