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FRM Part II · FRM Exam Part II · Derivatives

A bank has a single uncollateralised OTC swap with a corporate client. The swap currently has a negative mark-to-market from the bank's perspective. Which statement best describes the bank's current credit exposure to the client on this trade?

Current exposure equals zero. Credit exposure is the maximum of mark-to-market value and zero, since the bank only loses when the counterparty owes it money. A negative value means the bank owes the client, so there is no current credit loss at default.

  1. AIt equals the absolute value of the negative mark-to-market
  2. BIt equals zero, because exposure is floored at zeroCorrect
  3. CIt equals the notional amount of the swap
  4. DIt equals the negative mark-to-market multiplied by the client's loss given default

Explanation

Current exposure is the greater of the trade's mark-to-market value and zero, because the bank loses only if the counterparty defaults while the bank is owed money. With a negative value the bank owes the client, so current exposure is zero. Using the absolute value ignores the floor.

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