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

A bank estimates a counterparty's 97.5% potential future exposure at 25 million and its expected positive exposure at 9 million for a derivative portfolio. The PD is 2% and LGD is 60% over the horizon. Using the simple approximation CVA = EPE x PD x LGD, what is the CVA?

CVA is 0.108 million. Multiply the expected positive exposure of 9 million by the 2% default probability and 60% loss given default. The 97.5% PFE is a tail measure and is not appropriate for an average-loss adjustment.

  1. A0.108 millionCorrect
  2. B0.30 million
  3. C0.54 million
  4. D0.90 million

Explanation

CVA = 9 x 0.02 x 0.60 = 0.108 million. Using PFE gives 25 x 0.012 = 0.30 million, the wrong exposure metric. Omitting LGD gives 0.18; 0.54 and 0.90 are not derived from the data correctly.

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