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FRM Part II · FRM Exam Part II · Credit Risk

A bank has a single uncollateralized over-the-counter derivative with a corporate counterparty. The contract currently has a mark-to-market value of -USD 3 million to the bank (the bank owes the counterparty). Which statement best describes the bank's current counterparty credit exposure on this trade?

Current exposure is the greater of the mark-to-market value and zero. Because the bank owes USD 3 million, a counterparty default would cause no loss today, so exposure is zero. Taking the absolute value ignores that only positive values represent claims on the counterparty.

  1. AUSD 3 million, because exposure equals the absolute value of the mark-to-market
  2. BZero, because the bank would not lose anything if the counterparty defaulted todayCorrect
  3. CUSD 6 million, because exposure is twice the absolute mark-to-market
  4. DNegative USD 3 million, because exposure can be negative

Explanation

Current exposure is max(V, 0). With V = -3 million, the bank owes money, so a counterparty default produces no loss on this trade today, and exposure is zero. The USD 3 million option ignores the floor at zero. The bank could still face future exposure if the value turns positive.

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