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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A bank has an uncollateralised derivative portfolio with a corporate counterparty. Under the standard unilateral CVA framework, which expression best represents the credit valuation adjustment?

CVA is the risk-neutral expected loss from counterparty default. It is calculated as discounted expected positive exposure multiplied by the counterparty's marginal default probability and loss given default, summed across time. Own default probability drives DVA, and PFE is a percentile measure, not CVA.

  1. AExpected positive exposure multiplied by the bank's own probability of default
  2. BRisk-neutral expected loss from counterparty default: the discounted expected positive exposure times the counterparty's default probability and loss given defaultCorrect
  3. CThe difference between the risk-free value and the collateralised value of the portfolio
  4. DThe counterparty's potential future exposure at the 97.5th percentile discounted at the risk-free rate

Explanation

Unilateral CVA is the market value of expected credit loss: sum over time of discounted expected exposure times the marginal default probability of the counterparty times LGD. Using the bank's own default probability relates to DVA, not CVA. A percentile exposure measure is PFE, not an expected value.

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