What is a Swap?
A swap is a contractual agreement between two parties, called counterparties, where the counterparties agree to make periodic payments to each other.
Example
• Currencies Swap
• Interest rate swap
Risks in Swaps
• Interest rate risk
• Currency/exchange rate risk
• Credit default risk
• Liquidity risk
• Mismatch risk
• Basis risk
Credit default risk - Credit risk is defined as the probability of the counterparty in the swap agreement ceasing to exist, incorporating all the possible financial effects of the elimination. The reason for a counterparty becoming insolvent might be consequences of everything from bankruptcy to changes in the macroeconomic environment.
Credit Default Swaps - A CDS is a contract that provides protection against the risk of a credit event by a particular company or country.
Important terms in CDS
• Buyer
• Seller
• Reference entity
• Credit event
• Reference obligation
• Notional principal
Type of settlement
• Physical settlement
• Cash settlement
In layman’s terms the CDS is essentially an unregulated insurance policy, This obviously makes the sale of the Credit Default Swaps extremely profitable and default loss payments very expensive.
A swap is a contractual agreement between two parties, called counterparties, where the counterparties agree to make periodic payments to each other.
Example
• Currencies Swap
• Interest rate swap
Risks in Swaps
• Interest rate risk
• Currency/exchange rate risk
• Credit default risk
• Liquidity risk
• Mismatch risk
• Basis risk
Credit default risk - Credit risk is defined as the probability of the counterparty in the swap agreement ceasing to exist, incorporating all the possible financial effects of the elimination. The reason for a counterparty becoming insolvent might be consequences of everything from bankruptcy to changes in the macroeconomic environment.
Credit Default Swaps - A CDS is a contract that provides protection against the risk of a credit event by a particular company or country.
Important terms in CDS
• Buyer
• Seller
• Reference entity
• Credit event
• Reference obligation
• Notional principal
Type of settlement
• Physical settlement
• Cash settlement
In layman’s terms the CDS is essentially an unregulated insurance policy, This obviously makes the sale of the Credit Default Swaps extremely profitable and default loss payments very expensive.
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