Which of the following statements are true:

Credit risk is the risk from a borrower defaulting on moneys lent. Counterparty risk, on the other

hand, is the risk that a counterparty to a derivative transaction will be unable to pay at the time the

transaction is in-the-money.

Credit risk therefore relates more to the banking book, counterparty risk relates more to the trading

book. Credit risk and counterparty risk differ in that for counterparty risk, the amount at risk

fluctuates for counterparty risk depending upon the value of the underlying derivative. Counterparty

risk generally starts at zero, for most swaps and other derivatives are near zero value at inception.

Over time, as the prices of the underlying instruments move, one party ends up owing money to the

other. A deterioration in the financial situation of the party owing moneys may lead to a loss to the

other party, resulting in counterparty risk. Counterparty risk can also arise from stock lending

operations and repo trades.

Credit risk on the other hand is the traditional risk of default by a borrower, or a bank's customer

who has taken a loan or has an overdraft or other credit facility.

Statement I is therefore incorrect as credit risk and counterparty risks are different.

Statement II is correct as counterparty risk is 'contingent' in the sense it arises only if the transaction

with the counterparty ends up being in-the-money, and the counterparty defaults.

Statement III is incorrect. The statement describes credit risk.

Statement IV is incorrect, as the exposure is known for moneys lent. Derivative exposures for the

future are difficult to estimate, they can even turn from moneys owed to moneys due as the value of

the underlying changes.