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

A bank has three OTC derivative trades with a single counterparty under an enforceable close-out netting agreement. The trade mark-to-market values to the bank are +12 million, -5 million and +4 million. No collateral is held. What is the bank's current credit exposure to the counterparty?

The exposure is 11 million. Under an enforceable close-out netting agreement, the trades are combined into one net amount: 12 minus 5 plus 4 equals 11 million, which is positive, so that is the loss if the counterparty defaults with no collateral held.

  1. A21 million
  2. B11 millionCorrect
  3. C16 million
  4. D7 million

Explanation

With enforceable close-out netting, exposure is the maximum of the net value and zero. Net = 12 - 5 + 4 = 11 million. The 21 million figure ignores netting and sums only the positive trades; 16 million nets only the positive trade against nothing and omits the +4 incorrectly in a different way; 7 million wrongly nets the negative against only one positive.

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