LOS i, (Part 2): Illustrate how swap credit risk is reduced by both netting and marking to market.

Q1. Netting and marking to market are:

A) features of standardized futures contracts.

B) essentially the same thing.

C)ways to reduce the credit risk in swaps transactions.

Q2. Under a netting agreement swap, credit risk is:

A)   reduced with respect to a counterparty bankruptcy.

B)   reduced, except in the case of counterparty bankruptcy.

C)   unaffected.

Q3. Credit risk in a swap can be reduced by all of the following EXCEPT:

A)   marking to market when a trigger point is reached.

B)   netting agreements.

C)   increasing the floating rate to account for credit risk.

LOS i, (Part 2): Illustrate how swap credit risk is reduced by both netting and marking to market. fficeffice" />

Q1. Netting and marking to market are:

A) features of standardized futures contracts.

B) essentially the same thing.

C)ways to reduce the credit risk in swaps transactions.

Correct answer is C)

Netting and marking to market reduce the credit risk in swaps transactions and are often used with lower credit counterparties to lower potential credit risk.

Q2. Under a netting agreement swap, credit risk is:

A)   reduced with respect to a counterparty bankruptcy.

B)   reduced, except in the case of counterparty bankruptcy.

C)   unaffected.

Correct answer is A)

Under a netting agreement, swap credit risk is reduced with respect to a counterparty bankruptcy. Only the net difference in payments owed is at issue, compared to a situation where a party has a claim against the bankrupt firm's assets but has a liability to the bankrupt firm in the full amount of the gross payments owed to the firm on swaps.

Q3. Credit risk in a swap can be reduced by all of the following EXCEPT:

A)   marking to market when a trigger point is reached.

B)   netting agreements.

C)   increasing the floating rate to account for credit risk.

Correct answer is C)

Increasing the floating rate will not decrease the potential for default and may increase the amount at risk. Netting agreements and marking to market will reduce the amount of credit risk.