FRM Part II · FRM Exam Part II · Derivatives
A bank has three trades with one counterparty under a legally enforceable close-out netting agreement, with no collateral. Mark-to-market values to the bank are +USD 12 million, -USD 7 million and +USD 4 million. By how much does netting reduce the bank's current exposure compared with no netting?
Without netting, exposure sums only positive values: 12 plus 4, or USD 16 million. With enforceable close-out netting, values are summed first: 12 minus 7 plus 4 equals USD 9 million. Netting therefore reduces exposure by USD 7 million, the amount of the negative-valued trade.
- AUSD 7 millionCorrect
- BUSD 16 million
- CUSD 9 million
- DUSD 0
Explanation
Without netting, exposure is 12 + 0 + 4 = 16 million. With netting, exposure is max(12 - 7 + 4, 0) = 9 million. The reduction is 16 - 9 = 7 million. The 16 million option is the gross figure, and 9 million is the net exposure rather than the reduction.
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