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

A bank has three trades with one counterparty under a legally enforceable netting agreement, with no collateral. Mark-to-market values to the bank are +USD 10 million, +USD 6 million and -USD 7 million. Compared with exposure without netting, how does the netting benefit appear?

Exposure falls from USD 16 million to USD 9 million. Without netting only the positive trades count (10 + 6), but with netting the -7 offsets them, giving 9. Netting cannot increase exposure, and the negative trade is not added in absolute terms.

  1. AExposure falls from USD 16 million to USD 9 millionCorrect
  2. BExposure falls from USD 23 million to USD 9 million
  3. CExposure falls from USD 16 million to USD 6 million
  4. DExposure falls from USD 9 million to USD 16 million

Explanation

Without netting, exposure is the sum of positive values: 10 + 6 = 16 (the negative trade is floored at zero). With netting, exposure is max(10 + 6 - 7, 0) = 9. The reduction is USD 7 million. Using 23 wrongly adds the absolute value of the negative trade.

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