Discuss the problem of credit risk in swaps and how it is dealt with.
Swaps create credit risk or counterparty exposure on the other party to the contract.
This assumes the maximum credit exposure can be predetermined at the start. This revalues the exposure in terms of the cost to replace or hedge out the exposure at any time before the contract's maturity. At inception, an at-market swap will have a zero net present value after any adjustments. As the swap moves towards maturity it will become off-market and may become an asset or liability. Depending on the path of interest rates it may be subject to credit risk.