Reading 35: Swaps－LOS b 2008

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At the inception of either an interest rate or a commodity swap, who bears the most credit risk?

A) The fixed-rate payers in both cases bear the credit risk at inception.

B) There is no credit risk at the inception of either swap.

C) The floating-rate payers in both cases bear the credit risk at inception.

D) The fixed-rate payer in the commodity swap and the floating-rate payer in the interest rate swap bear the credit risk at the inception of the respective swaps.

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Answer and Explanation

Both swaps have a zero market value at inception, so there is no credit risk for either party in either case.

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CFA Institute Area 8-11, 13: Asset Valuation
Session 11: Alternative Investments for Portfolio Management
Reading 35: Swaps
LOS b: Evaluate hedging strategies that rely on swaps and illustrate their inherent risk exposures.

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Charles Briggs, CFA, wants to effectively hedge against changes in the value of a commodity swap in which he has a position. Briggs plans to only use futures contracts. To effectively hedge the value of the swap, Briggs will need to use:

A) commodity futures only.

B) interest rate futures only.

C) both commodity futures and interest rate futures.

D) neither commodity futures nor interest rate futures.

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Answer and Explanation

Since the value of a commodity swap is the present value of a fully hedged swap, to effectively hedge the value Briggs will need to use both types of futures contracts to hedge the risk of changing commodity prices and interest rates.

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Which of the following types of risk that a position in a commodity swap is exposed to is least accurate?

A) interest-rate risk.

B) J-factor risk.

C) credit risk.

D) market risk from changes in commodity prices.

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Answer and Explanation

A commodity swaps value will change from both changes in interest rates and commodity prices. An investor faces credit risk any time the value of the commodity swap is greater than zero. J-factor risk refers to the risk investors in distressed debt face from judicial decisions. It is not generally associated with commodity swaps.