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FRM Part I · FRM Exam Part I · Measuring Credit Risk

A bank has a USD 50 million exposure and a collateral pool valued at USD 50 million today. The collateral has a 10-day price volatility of 8% and the bank wants 99% coverage (z = 2.33) over the close-out period. Using a haircut equal to z times volatility, what is the approximate collateral value after haircut, and what is the uncovered exposure?

Collateral is worth about USD 40.7 million after the haircut, leaving about USD 9.3 million uncovered. The haircut is 2.33 times 8%, or 18.64%, which reduces USD 50 million to 40.68 million. The shortfall against the USD 50 million exposure is 9.32 million.

  1. AUSD 40.7 million after haircut; USD 9.3 million uncoveredCorrect
  2. BUSD 31.4 million after haircut; USD 18.6 million uncovered
  3. CUSD 46.3 million after haircut; USD 3.7 million uncovered
  4. DUSD 40.7 million after haircut; USD 4.7 million uncovered

Explanation

Haircut = 2.33 x 8% = 18.64%. Haircut collateral = 50 x (1 - 0.1864) = USD 40.68 million, about 40.7. Uncovered = 50 - 40.68 = USD 9.32 million, about 9.3. Using 2.33 x 8% applied twice gives 31.4, which is wrong.

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