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

A bank has two uncollateralised trades with one counterparty, with no netting agreement. Trade A has a current mark-to-market of +USD 12 million to the bank, and Trade B has a current mark-to-market of -USD 7 million. Under a legally enforceable close-out netting agreement, how does current exposure change, and what is the exposure without netting versus with netting?

Without netting the exposure is USD 12 million, the sum of positive trade values, and with enforceable netting it is USD 5 million, the maximum of the net value (12 minus 7) and zero. Netting lets the negative trade offset the positive one.

  1. AWithout netting 12 million; with netting 5 millionCorrect
  2. BWithout netting 5 million; with netting 12 million
  3. CWithout netting 12 million; with netting 19 million
  4. DWithout netting 19 million; with netting 5 million

Explanation

Without netting, the bank owes the negative trade in full to the estate but claims only the positive one, so exposure is the sum of positive values: max(12,0)+max(-7,0)=12. With netting, exposure is max(12-7,0)=5. The 19 figure adds absolute values, which is wrong.

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