Impact of Credit Default Swaps on Credit Risk Management

Hard Risk Management Applications Credit Risk Management

ABC Investment Firm manages a diversified portfolio that includes a significant allocation to corporate bonds. Recently, the firm has expressed concerns about increasing credit risk associated with these bond holdings due to economic uncertainties. To mitigate potential losses from default, the portfolio manager is considering implementing a few different credit risk management strategies.

One of the specific strategies involves considering the implementation of credit default swaps (CDS) as a form of credit protection. The portfolio manager is evaluating the effectiveness and implications of using CDS compared to other risk management tools available in the market.

Which of the following statements best describes the impact of using credit default swaps in the context of credit risk management for the portfolio?

Credit default swaps can transform the nature of the risk exposure, as they allow the investor to receive protection against defaults while still retaining the underlying bond position.

Using credit default swaps increases the overall credit risk of the portfolio, as they might lead to a concentration in fewer credit exposures.

Credit default swaps are less liquid than the underlying corporate bonds, which makes them less effective for hedging purposes.

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