A credit default swap is primarily used to manage what type of risk?

A credit default swap is primarily used to manage what type of risk?

• A. Market risk
• B. Operational risk
• C. Credit risk
• D. Liquidity risk

Answer: (C)

A credit default swap (CDS) is a financial derivative that allows one party to transfer the risk of credit default of a borrower to another party. The primary purpose of a CDS is to provide protection against the risk of default on a debt instrument, such as a bond or loan. When a party purchases a CDS, they essentially pay a premium to the seller of the swap in exchange for a guarantee that they will be compensated if the borrower defaults on their obligations. This mechanism is specifically designed to manage credit risk, which arises from the possibility that a borrower will be unable to meet their debt obligations. By entering into a CDS, investors can hedge against potential losses that may arise from defaults, allowing them to manage their exposure to credit risk effectively. Other types of risks mentioned in the options—market risk, operational risk, and liquidity risk—are addressed through different financial instruments and strategies, highlighting that the primary function of a credit default swap is indeed to manage credit risk.

A credit default swap (CDS) is a financial derivative that allows one party to transfer the risk of credit default of a borrower to another party. The primary purpose of a CDS is to provide protection against the risk of default on a debt instrument, such as a bond or loan. When a party purchases a CDS, they essentially pay a premium to the seller of the swap in exchange for a guarantee that they will be compensated if the borrower defaults on their obligations.

This mechanism is specifically designed to manage credit risk, which arises from the possibility that a borrower will be unable to meet their debt obligations. By entering into a CDS, investors can hedge against potential losses that may arise from defaults, allowing them to manage their exposure to credit risk effectively.

Other types of risks mentioned in the options—market risk, operational risk, and liquidity risk—are addressed through different financial instruments and strategies, highlighting that the primary function of a credit default swap is indeed to manage credit risk.