RSK4804
Assignment 2
Unique No: 865771
Due 30 August 2025
, •
RSK4804
Assignment 2
Unique number 865771
Due date: 30 August 2025
Exceptional Solutions & Interpretation
Credit Risk Management
Question 1: Credit Default Swaps
a. Necessity of Credit Default Swaps
Credit default swaps (CDS) are financial derivatives that transfer credit risk, serving as a
critical tool in credit risk management. Their necessity stems from:
• Hedging Credit Risk: CDS protect against default on debt instruments. For example,
a bank can purchase a CDS to mitigate losses if a bond issuer defaults (?).
• Portfolio Diversification: CDS enable exposure to credit markets without owning
bonds, aiding diversification.
• Capital Efficiency: CDS reduce regulatory capital requirements under Basel I, freeing
capital for lending.
• Market Liquidity: CDS enhance liquidity and price discovery by allowing speculation
on creditworthiness.
Critically, unregulated CDS use, as in 2008, amplified systemic risks, necessitating robust
oversight .
1
Assignment 2
Unique No: 865771
Due 30 August 2025
, •
RSK4804
Assignment 2
Unique number 865771
Due date: 30 August 2025
Exceptional Solutions & Interpretation
Credit Risk Management
Question 1: Credit Default Swaps
a. Necessity of Credit Default Swaps
Credit default swaps (CDS) are financial derivatives that transfer credit risk, serving as a
critical tool in credit risk management. Their necessity stems from:
• Hedging Credit Risk: CDS protect against default on debt instruments. For example,
a bank can purchase a CDS to mitigate losses if a bond issuer defaults (?).
• Portfolio Diversification: CDS enable exposure to credit markets without owning
bonds, aiding diversification.
• Capital Efficiency: CDS reduce regulatory capital requirements under Basel I, freeing
capital for lending.
• Market Liquidity: CDS enhance liquidity and price discovery by allowing speculation
on creditworthiness.
Critically, unregulated CDS use, as in 2008, amplified systemic risks, necessitating robust
oversight .
1
