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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

A bank has two OTC derivative portfolios with the same dealer. Under a legally enforceable bilateral netting agreement, portfolio A has a mark-to-market of +USD 30 million to the bank and portfolio B has -USD 22 million. The dealer defaults. Ignoring collateral, what is the bank's credit exposure to the dealer and what would it be without netting enforceability?

With enforceable netting, the bank's exposure is the net USD 8 million (30 minus 22). Without netting, it still owes the USD 22 million but is an unsecured creditor for the full USD 30 million, so its exposure is USD 30 million.

  1. AUSD 8 million with netting; USD 30 million withoutCorrect
  2. BUSD 52 million with netting; USD 30 million without
  3. CUSD 8 million with netting; USD 22 million without
  4. DUSD 30 million with netting; USD 8 million without

Explanation

With netting, exposure is 30 - 22 = USD 8 million. Without netting, the bank must pay the USD 22 million it owes but claims only as an unsecured creditor on the USD 30 million, so exposure is USD 30 million. The USD 52 million option adds the amounts incorrectly.

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