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FRM Part II · FRM Exam Part II · Future Value and Exposure

A bank buys a 1-year European call option from a counterparty, paying the premium upfront. Which statement best describes the bank's counterparty credit exposure and the counterparty's exposure to the bank?

The bank, as option buyer, has one-way exposure equal to the option's current positive market value, while the seller has none once the premium is paid. The option's value cannot be negative to the holder, and it varies with the underlying rather than staying at the premium.

  1. AThe bank's exposure is only positive and equals the option's positive market value; the counterparty has no exposure after premium is paidCorrect
  2. BBoth parties have exposure because the option value can be negative for the buyer
  3. CThe bank has no exposure because the premium has been paid
  4. DThe bank's exposure equals the premium paid and is constant over time

Explanation

A long option has value that is never negative to the holder, so the holder faces one-way credit exposure equal to the current option value. Once the premium is paid the writer has no claim on the buyer. The exposure moves with the option's value, not with the premium.

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