Reading 37: Risk Management －LOS i investment, including, contract

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 12: Risk Management
Reading 37: Risk Management
LOS i: Evaluate the credit risk of an investment position, including forward contract, swap, and option positions.

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Which of the following will have the least amount of credit risk? A(n):

A) short option position.

B) pay-fixed position in a plain-vanilla interest rate swap.

C) pay-floating position in a plain-vanilla interest rate swap.

D) either position in a plain-vanilla currency swap.

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Answer and Explanation

The holder of a short option position has received all the income it can expect. Thus, it has no credit risk. All the other listed positions have some credit risk.

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The long position of a forward contract bears the credit risk if the market price of the underlying is:

A) less than the exercise price.

B) greater than the exercise price.

C) equal to the exercise price.

D) more stable.

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Answer and Explanation

This is true because the long position will be in-the-money, which means there is a possibility of not being paid what is owed.

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Prior to expiration, the long position in a European option would have:

A) more current credit risk than potential credit risk.

B) an equal amount of current and potential credit risk.

C) only potential credit risk.

D) zero credit risk.

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Answer and Explanation

Since the long position can only be owed money at expiration, then that is when there is current credit risk. Prior to that, there can only be potential credit risk.