Understanding Credit Default Swaps in Risk Management

Credit risk is an essential consideration for portfolio managers, particularly when evaluating bond investments and credit derivatives. One effective method to manage credit risk is through the use of credit derivatives, such as credit default swaps (CDS). These instruments allow investors to hedge against the risk of default by a borrower. Understanding the implications of such hedging strategies is crucial for risk management.

Suppose an investment manager is considering the use of a CDS on a corporate bond issued by Company X. The CDS would provide protection against defaults while also impacting the overall risk exposure of the portfolio. Meanwhile, several external credit ratings from agencies like Moody's and S&P provide insights into the creditworthiness of Company X.

Which of the following statements correctly describes an implication of using a credit default swap for managing credit risk?