Skip to content

FRM Part II · FRM Exam Part II · Derivatives

A bank enters a receiver swap with a counterparty whose default probability tends to rise when interest rates fall, which is when the swap has the greatest positive value to the bank. What effect does this have on CVA?

CVA is higher than the independence-based figure because of wrong-way risk. The counterparty is more likely to default exactly when the bank's exposure is largest, so expected loss exceeds what is obtained by multiplying exposure and default probability independently.

  1. ACVA is lower than the independence-based calculation because exposure falls when default occurs
  2. BCVA is higher than the independence-based calculation because of wrong-way riskCorrect
  3. CCVA is unchanged because exposure and default are assumed independent
  4. DCVA becomes equal to DVA

Explanation

When exposure is high at the same time as the counterparty's default probability is high, this is wrong-way risk. Expected loss given default is larger than under the independence assumption, which multiplies EPE by PD separately. CVA therefore rises.

Did you get it right without looking?

One question tells you little. A timed set on Derivatives shows your real accuracy, how long you take and where you lose marks.

Practise DerivativesFree diagnostic mock

More Derivatives questions