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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 trades have mark-to-market values to the bank of +USD 14 million, -USD 6 million and +USD 4 million. No collateral is held. What is the bank's current credit exposure to the counterparty?

The exposure is USD 12 million. Under an enforceable close-out netting agreement, trade values are summed across the netting set, giving 14 minus 6 plus 4, and floored at zero. Summing only the positive trades, USD 18 million, would ignore netting.

  1. AUSD 18 million
  2. BUSD 12 millionCorrect
  3. CUSD 24 million
  4. DUSD 4 million

Explanation

With enforceable netting, exposure is max(sum of values, 0) = max(14 - 6 + 4, 0) = USD 12 million. The gross figure of USD 18 million ignores the netting benefit by summing only positive values. USD 24 million adds absolute values, and USD 4 million counts only one trade.

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