A bank lender is concerned about the creditworthiness of one of its major borrowers. The bank is considering using a swap to reduce its credit exposure to this customer. Which type of swap would best meet this need?

Question

Quizplus · Accepted Answer

A Credit default swap (CDS) would best meet the bank lender's needs, as it is specifically designed to transfer credit risk. By purchasing a CDS from a counterparty, the bank can receive protection against the risk of default by the borrower. This can reduce the bank's credit exposure to the borrower and potentially lower the capital reserves required for the loan. Interest rate swaps, currency swaps, equity-linked swaps, and DIF swaps are not specifically designed to address credit risk.

A Bank Lender Is Concerned About the Creditworthiness of One