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FRM Part II · FRM Exam Part II · Credit Risk Management

A bank has a single uncollateralized interest rate swap with a corporate client. The swap's current mark-to-market value to the bank is negative USD 4 million. Which statement best describes the bank's current exposure to the client on this trade?

Current exposure is zero. Credit exposure equals the greater of the contract's mark-to-market value and zero. A negative value means the bank owes the client, so a client default would not cause a credit loss on this trade.

  1. AUSD 4 million, because exposure equals the absolute value of the mark-to-market
  2. BZero, because exposure is the greater of the mark-to-market value and zeroCorrect
  3. CUSD 4 million, because the bank would owe this amount and must hedge it
  4. DNegative USD 4 million, because exposure can be negative for the bank

Explanation

Current exposure is max(V, 0). With V = -4 million, the bank owes the client and would lose nothing if the client defaulted, so credit exposure is zero. The absolute-value option confuses a liability with a claim on the counterparty.

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