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FRM Part II · FRM Exam Part II · Derivatives

A bank has an uncollateralised OTC derivative portfolio with a corporate client. In calculating the unilateral CVA on this portfolio, which exposure measure is used to weight the counterparty's default probabilities?

CVA weights marginal default probabilities by discounted expected positive exposure, because only positive value to the bank is lost if the counterparty defaults. Negative exposure relates to DVA, and high-percentile PFE or current MTM alone do not give the expected loss.

  1. ADiscounted expected positive exposure at each future dateCorrect
  2. BDiscounted expected negative exposure at each future date
  3. CCurrent mark-to-market value of the portfolio only
  4. DPotential future exposure at the 99th percentile at each date

Explanation

Unilateral CVA is the risk-neutral expected loss from counterparty default: (1 - recovery) times the sum of discounted expected positive exposure times marginal default probability. Expected negative exposure drives DVA, not CVA. PFE at a high percentile is a limit-setting measure, not an expectation, so it would overstate CVA.

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