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

A bank estimates a counterparty's exposure at a future date as: 40% probability of a mark-to-market value of +USD 20 million, 20% probability of USD 0, and 40% probability of -USD 10 million. The positive exposure is floored at zero. What are the expected exposure (EE) and expected negative exposure (ENE, stated as a positive amount of the bank's liability)?

Expected exposure is USD 8 million, being 40% of 20 million with the negative outcome floored at zero. Expected negative exposure is USD 4 million, being 40% of the 10 million liability. The net expected value of USD 4 million is not the exposure.

  1. AEE = USD 8 million; ENE = USD 4 millionCorrect
  2. BEE = USD 4 million; ENE = USD 8 million
  3. CEE = USD 8 million; ENE = USD 10 million
  4. DEE = USD 4 million; ENE = USD 4 million

Explanation

EE = 0.4 x 20 + 0.2 x 0 + 0.4 x max(-10,0) = 8 million. ENE = 0.4 x 10 = 4 million (the average of the negative part). Option with EE of 4 uses net expected value 8 - 4 = 4, which mixes the two sides.

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