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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A bank has two OTC derivative trades with a counterparty under a legally enforceable close-out netting agreement. Trade A has a mark-to-market value of +USD 12 million to the bank and Trade B has a mark-to-market value of -USD 7 million. Ignoring collateral, what is the bank's current exposure to the counterparty?

The exposure is USD 5 million. Under enforceable close-out netting, the positive and negative values are offset into a single net amount of 12 minus 7, and exposure equals the greater of that net figure and zero. Without netting, exposure would be USD 12 million.

  1. AUSD 12 million
  2. BUSD 5 millionCorrect
  3. CUSD 19 million
  4. DUSD 7 million

Explanation

With enforceable close-out netting, exposure is the maximum of the net value and zero: max(12 - 7, 0) = USD 5 million. USD 12 million ignores netting, treating only the positive trade as exposure. USD 19 million adds absolute values, which is wrong.

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