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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A bank computes the credit valuation adjustment (CVA) on an uncollateralised portfolio of interest rate swaps with a corporate client. Which statement best describes what the CVA represents?

CVA is the market value of the expected loss from the counterparty's default. It is deducted from the risk-free portfolio value to give the value that reflects counterparty credit risk. DVA, by contrast, reflects the bank's own default, and CVA is not a margin or capital figure.

  1. AThe market value of the expected loss from counterparty default, deducted from the risk-free value of the portfolioCorrect
  2. BThe value of the bank's own default option, added to the portfolio value
  3. CThe regulatory capital charge held against the counterparty's rating migration
  4. DThe initial margin the bank must post to the counterparty

Explanation

CVA is the difference between the risk-free portfolio value and the true portfolio value that allows for counterparty default. It is the market price of expected counterparty credit loss. The bank's own default option is DVA, not CVA, and CVA is a valuation adjustment, not a margin amount.

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