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

A bank has two trades with the same counterparty under a legally enforceable netting agreement. Trade A has a mark-to-market value of +USD 12 million to the bank and Trade B has a value of -USD 5 million. The counterparty defaults and there is no collateral. What is the bank's exposure, and what is the exposure without netting?

Exposure is USD 7 million with netting, since the positive and negative values offset to 12 minus 5. Without netting it is USD 12 million, because only the positive trade counts as a claim and the negative trade is floored at zero.

  1. AUSD 7 million with netting; USD 12 million without nettingCorrect
  2. BUSD 12 million with netting; USD 7 million without netting
  3. CUSD 7 million with netting; USD 17 million without netting
  4. DUSD 5 million with netting; USD 12 million without netting

Explanation

With netting, exposure is max(12 - 5, 0) = 7 million. Without netting, the bank must still pay 5 million on Trade B to the estate but only claims on Trade A: exposure is max(12,0)+max(-5,0) = 12 million. Adding absolute values (17) is wrong.

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