24-77 When are the standby letters of credit used in swap agreements?
A)When the counterparty is perceived to be of significantly lower credit quality than the other party.
B)Where the swap agreement is made between parties of equal credit standing.
C)Where the swap agreement is made between high-quality counterparties.
D)When one party posts collateral in lieu of default.
E)When the no-arbitrage condition does not hold good.

Question

Quizplus · Accepted Answer

Standby letters of credit are often used in swap agreements when one counterparty is perceived to be of significantly lower credit quality than the other party. The higher quality party may require the lower quality party to provide a standby letter of credit to assure payment in the event of default. This helps to mitigate credit risk for the higher quality party.

24-77 When Are the Standby Letters of Credit Used in Swap