Lesson 22 of 25
Current Credit Risk: The situation where one swap party is owed a payment now and the other party cannot make the payment.
Potential Credit Risk: The possibility that the other party may default in the future.
The amount at risk for default is equal to the swap's market value at any given point in time.
While swaps are over the counter, the parties can agree to a marking to market method for controlling credit risk.
Swap spread is the difference between a swap's fixed rate and an equal maturity risk free rate, such as the yield on government debt with a same maturity.
Swap rates can be quoted as a spread over equivalent risk free rates; this spread can be interpreted as a gauge of credit risk in the general market.
During times of economic turmoil, swap spreads tend to widen.