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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A bank and a counterparty each have independent default times with constant hazard rates. The bank is exposed to the counterparty on a single forward whose exposure is positive for the bank in some scenarios and negative in others. Which statement about bilateral CVA calculation with first-to-default considerations is correct?

The CVA term must be weighted by the bank's survival probability and the DVA term by the counterparty's survival probability, because the contract terminates at the first default. Ignoring this double counts, and bilateral adjustment is generally smaller than unilateral CVA.

  1. AThe counterparty's CVA term should be weighted by the probability that the bank has not defaulted earlier, and the DVA term by the probability the counterparty has not defaulted earlierCorrect
  2. BCVA and DVA can be computed independently and simply summed without any survival adjustment
  3. CDVA should be computed using only the counterparty's survival probability
  4. DBilateral CVA is always larger than unilateral CVA

Explanation

Because the contract ends at the first default, the loss from the counterparty's default only matters if the bank has survived to that time, and similarly for DVA. Ignoring this double counts. Bilateral CVA (net of DVA) is typically smaller than unilateral CVA, so the last option is wrong.

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