In a currency swap, when is the credit risk typically highest?

The highest credit risk in a currency swap typically occurs at the midpoint and the end of the swap life due to the nature of the cash flows involved and the changes in market conditions over time.

At the start of the swap, the cash flows are evenly distributed, and the net exposure may be lower since parties are just entering into the agreement. However, as the swap progresses, fluctuations in currency exchange rates can lead to one party having a significantly higher liability compared to the other. This can create a larger net exposure to credit risk, especially as payments become due at various points throughout the duration of the swap.

By the midpoint and at the end of the swap, the accumulated net exposure can lead to situations where one party may face larger obligations than the other, heightening the overall credit risk. Additionally, as the end date approaches, the likelihood of default increases if the counterparty's financial condition deteriorates, hence contributing to a peak in credit risk exposure at those times.

This perspective on the timing of credit risk aligns with the dynamics of payment structures in swaps, where cash flows can be impacted by market movements and the overall financial health of the parties involved.