Answer: Wrong-way risk  Right-way risk

## Explanation **Right-way risk** occurs when the probability of counterparty default decreases as the exposure to that counterparty increases. **Wrong-way risk** occurs when the probability of counterparty default increases as the exposure to that counterparty increases. **Analysis:** - **Hedge Fund**: Has wrong-way risk. When interest rates rise, the credit quality of Bank HJK deteriorates (increased credit spread), which means the probability of Bank HJK defaulting increases. At the same time, rising interest rates typically increase the value of interest rate derivatives (like swaps), which would increase the hedge fund's exposure to Bank HJK. So we have increasing exposure coinciding with increasing probability of default - this is wrong-way risk. - **Manufacturer**: Has right-way risk. When interest rates rise, the manufacturer's exposure to Bank HJK would typically decrease (as the value of their interest rate derivatives would move against them), while the probability of Bank HJK defaulting increases. So we have decreasing exposure coinciding with increasing probability of default - this is right-way risk. Therefore, the correct answer is **B: Wrong-way risk for the hedge fund, Right-way risk for the manufacturer**.

Author: LeetQuiz .