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

A bank computes unilateral CVA on a swap with counterparty A and then adds a bilateral adjustment. The swap's unilateral CVA is 0.90 million. The bank's expected negative exposure, taken together with its own default probabilities and loss given default, gives a DVA of 0.35 million. Ignoring first-to-default effects, what is the bilateral CVA (net adjustment to the risk-free value), and how does it change the portfolio value?

The bilateral adjustment is CVA minus DVA, which is 0.90 − 0.35 = 0.55 million. This is a net charge, so the portfolio value falls by 0.55 million. Adding the two figures would wrongly treat DVA as an additional cost.

  1. ANet charge of 0.55 million, reducing the portfolio value by 0.55 millionCorrect
  2. BNet charge of 1.25 million, reducing the portfolio value by 1.25 million
  3. CNet credit of 0.55 million, increasing the portfolio value
  4. DNet charge of 0.35 million, reducing the portfolio value by 0.35 million

Explanation

Bilateral CVA = CVA − DVA = 0.90 − 0.35 = 0.55 million, a net charge that reduces value. Adding the two (1.25) is the sign error. A net credit would require DVA to exceed CVA.

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