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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

A bank has n identical trades with a counterparty, each with the same exposure volatility and pairwise correlation rho between trade values, with zero mean values. Using the standard approach, the netting factor is the ratio of netted to un-netted exposure, sqrt(n + n(n-1)rho)/n. For n = 10 and rho = 0.2, what is the approximate netting factor?

The netting factor is about 0.52. With n = 10 and rho = 0.2, the term under the root is 10 + 90 x 0.2 = 28, whose square root is about 5.29. Dividing by 10 gives roughly 0.53, meaning netting cuts exposure by almost half.

  1. A0.52Correct
  2. B0.36
  3. C0.20
  4. D0.72

Explanation

Inside root: 10 + 10*9*0.2 = 10 + 18 = 28. sqrt(28) = 5.29. Divide by 10 gives 0.529, about 0.52 to 0.53. Using rho=0 gives sqrt(10)/10 = 0.32; rho=1 gives 1.

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