Skip to content

FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk

A bank has a derivatives portfolio with a single counterparty under a legally enforceable close-out netting agreement. Which of the following best describes the effect of netting on the bank's credit exposure to that counterparty?

Close-out netting combines all trades with a defaulting counterparty into one net claim, so exposure equals the net positive value rather than the sum of positive values. It does not alter default probability or move exposure to a central counterparty.

  1. AIt replaces the sum of positive and negative trade values with a single net amount, reducing exposure to the net positive value on defaultCorrect
  2. BIt eliminates the counterparty's probability of default
  3. CIt transfers the exposure to a central counterparty at all times
  4. DIt increases gross exposure but lowers the loss given default rate

Explanation

Close-out netting lets the bank offset positive and negative mark-to-market values with the same counterparty upon default, so the claim equals the net amount if positive. Without netting, the bank could be forced to pay what it owes while only receiving a fraction of what it is owed. Netting does not change default probability.

Did you get it right without looking?

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

Practise Fundamentals of Credit RiskFree diagnostic mock

More Fundamentals of Credit Risk questions