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FRM Part I · FRM Exam Part I · Introduction to Derivatives

A bank has two OTC trades with a dealer, one with a mark-to-market value of +USD 12 million and another with -USD 9 million. Both are legally covered by an enforceable netting agreement, and no collateral is posted. If the dealer defaults, what is the bank's exposure under close-out netting, ignoring recovery?

The exposure is USD 3 million. With an enforceable netting agreement, the two trade values are offset on default, so the bank's claim is 12 minus 9. The USD 12 million figure ignores netting, and the others misuse the trade values.

  1. AUSD 12 million
  2. BUSD 3 millionCorrect
  3. CUSD 21 million
  4. DUSD 9 million

Explanation

Close-out netting combines the positive and negative values: 12 - 9 = USD 3 million owed by the dealer. Without netting the exposure would be USD 12 million, the gross positive value. USD 21 million adds the absolute values, and USD 9 million considers only the negative trade.

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