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I'm currently examining ways to manage the credit exposure on an interest rate swap and cross currency interest rate swap by using credit default swaps. The exposures are related to IRS and CCIRS transactions with corporates (so not banks and other counterparties with whom there is usually some sort of collateral agreement in place). Does anyone has experience in this field? I'm struggling with the following related issues:-Given the dynamic nature of an IRS or CCIRS exposure, what would be the best way to use a CDS to manage this risk (for instance on a transaction basis)?-Would you have to buy protection on the worst-case scenario or on the current exposure?-Is it possible to enter into a CDS contract which has for instance an underlying value/characteristics that is equal (including amortizations) to the IRS or CCIRS itself?-Does it make economic sense to use a CDS to manage the credit exposure resulting from IRS/CCIRS transactions, or would that wipe out the P&L of such a transaction?Any information on this subject is highly appreciated.K.

K,This is an interesting topic. People try to tranfer credit risk to market risk. Some firm use risk participant swap (PRS) as a tool. To answer your question, my personal thinking is1. With the liquidity of CDS, it appears that CDS or CDS option is more suitable for this purpose.2. The protection should be target for the average expected exposure or risk equivalent (RQ).3. That depends your goal to against current exposure or RQ or peak exposure.4. Most cases for this kind of swaps, the counter party has a lower rating, or you can not get the netting or collateral in place properly as defined by ISDA master agreement. You would charge the counter-party a higher rate( inclued a cerdit charge). Some firm would reserve a cash for the possible default, which is more expensive. If you buy protecting through CDS or related credit derivative, it should be cheaper than cash reserv.Hope this will help you!E.