FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond
A bank has a single uncollateralized derivative with a counterparty. The current mark-to-market value of the trade to the bank is -USD 4 million. Under the usual definition of current exposure, what is the bank's current exposure to this counterparty?
The current exposure is zero. Current exposure equals the greater of the trade's mark-to-market value and zero. Because the trade is worth -USD 4 million to the bank, the bank owes the counterparty and would not lose anything if the counterparty defaulted.
- AUSD -4 million
- BUSD 4 million
- CUSD 0Correct
- DUSD 8 million
Explanation
Current exposure is the greater of the contract's replacement value and zero, because the bank loses nothing from the counterparty's default when it owes money (ignoring any recovery claims by the defaulter's estate on the bank's side). With a value of -4 million, max(-4, 0) = 0. Reporting 4 million ignores that exposure is floored at zero.
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