Credit Risk Management Practice Exam

Which method is NOT commonly used to manage counterparty risk?

1. Diversifying counterparty risk

2. Collateralization

3. Issuing bonds

4. Close-out provisions

The correct answer is: Issuing bonds

The method that is not commonly used to manage counterparty risk is issuing bonds. In the context of counterparty risk management, the focus is typically on mitigating the risk posed by counterparties failing to fulfill their financial obligations. Strategies like diversifying counterparty risk involve spreading exposure across multiple parties to reduce the impact of any single counterparty's failure. Collateralization requires counterparties to pledge assets as security against credit exposure, providing a safety net if they default. Close-out provisions allow parties to terminate agreements and liquidate positions to minimize potential losses in the event of a counterparty's insolvency. Issuing bonds, on the other hand, is a method used by entities to raise capital rather than to manage the risks associated with counterparty relationships. While bonds can represent a form of credit risk, they do not directly address the specific concerns of counterparty risk in transactional contexts.