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FRM Part II · FRM Exam Part II · Future Value and Exposure

A bank has two OTC derivative trades with the same counterparty under a legally enforceable netting agreement. Trade A has a current mark-to-market value of +USD 12 million to the bank, and Trade B has a current value of -USD 5 million to the bank. What is the bank's current exposure to the counterparty?

The current exposure is USD 7 million. Under an enforceable netting agreement the trade values are summed, so +12 and -5 give a net +7. Exposure is the positive net amount. Ignoring netting would give USD 12 million, which overstates the loss on default.

  1. AUSD 12 million
  2. BUSD 7 millionCorrect
  3. CUSD 5 million
  4. DUSD 17 million

Explanation

With enforceable netting, the positive and negative values are offset: 12 - 5 = 7. Current exposure is max(net value, 0) = USD 7 million. Using only the positive trade (12) ignores netting, while 17 adds absolute values and 5 uses only the negative leg.

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