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

A bank has a single uncollateralised forward contract with a corporate client. The contract's current mark-to-market value is negative for the bank (a liability). If the client defaults today, what is the bank's current credit exposure to the client on this trade?

The current exposure is zero. Exposure equals the larger of the mark-to-market value and zero, so when the bank owes the client, it has nothing to lose from the client's default; the liability is still owed and does not create credit exposure.

  1. AThe absolute value of the negative mark-to-market
  2. BZeroCorrect
  3. CHalf of the absolute mark-to-market value
  4. DThe notional amount of the contract

Explanation

Credit exposure is the greater of the contract's value and zero, because the bank would not lose from a defaulting counterparty when it owes money on the trade. The exposure is therefore max(V, 0) = 0. The absolute value would wrongly treat the liability as an amount the bank could lose.

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