Question

5. Which of the following is true for the party paying fixed in an interest rate swap? Assume no other transactions with the counterparty. A. There is more credit risk when the yield curve is upward sloping than when it is downward sloping B. There is more credit risk when the yield curve is downward sloping than when it is upward sloping C. The credit exposure increases when interest rates decline D. There is no credit exposure providing a financial institution is used as the intermediary

Answer 1

Answer:

The answer is option A, There is more credit risk when the yield curve is upward sloping than when it is downward sloping

Explanation:

Solution

In an interest swap rate, when we receive floating, and pay fixed, in upward sloping yield curve, we are going to receive increase of  cash flows and therefore going to pay fixed and so, the counterpart will be at  a loss in slopping upward yield curve, and hence, we will have a credit risk that will be greater.