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

A bank calculates bilateral CVA for an uncollateralised derivatives portfolio with a corporate client. Relative to its unilateral CVA (which considers only the counterparty's default), which statement best describes the effect of including the bank's own default risk?

Bilateral CVA is lower than unilateral CVA. Including the bank's own default adds a debit valuation adjustment, a gain from not fully paying liabilities if it defaults first, and this is subtracted from the CVA charge, reducing the net adjustment.

  1. ABilateral CVA is lower than unilateral CVA because a debit valuation adjustment offsets part of the chargeCorrect
  2. BBilateral CVA is higher than unilateral CVA because own default adds a second cost
  3. CBilateral CVA equals unilateral CVA because own default affects only the funding cost
  4. DBilateral CVA is unaffected by own credit spreads but depends on the counterparty's recovery rate only

Explanation

Bilateral CVA = CVA minus DVA. DVA reflects the benefit to the bank of not having to pay the full negative exposure if it defaults first, so it reduces the net adjustment. Adding own default therefore lowers the charge relative to the unilateral figure.

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