Swap: Credit risk

• "Because currency swaps almost always include netting agreements and interest rate swaps can be structured to include mark-to-market agreements, we can significantly reduce the credit risk of these swap instruments by negotiating swap contracts that include these respective features. When negotiating these features is not possible, credit risk can be reduced by using off-market swaps that do not require an initial payment from our firm."

(Question)
Evaluate the statements regarding the firm's ability to mitigate the credit risk inherent in currency swaps and interest rate swaps. It is only correct regarding:

A. netting agreements.
B. mark-to-market agreements.
C. off-market swap contracts.

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Answer: B

Drecresing credit risk

	Currency swaps	Interest rate swaps	Equity swaps	Interest rate swaps	Off-market swaps
Netting payments	N/A	Yes	Yes
Mark-to-market agreements		Yes
No initial payment?

Using off-market swaps is not generally a method to reduce credit risk. If the firm enters into an off-market swap in which they do not owe a payment, then a payment is owed to the firm by the counterpary. This would actually increase credit risk since the counterparty could potentially default on the initial payment.