FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk
A bank holds a USD 50 million loan to a corporate borrower, secured by bonds worth USD 40 million. Under a simple haircut approach, the bonds receive a 10% haircut for price volatility, and there is no currency mismatch. Ignoring any other adjustments, what is the bank's unsecured exposure after collateral?
The unsecured exposure is USD 14 million. The bonds are haircut by 10% to USD 36 million, and subtracting this from the USD 50 million loan leaves USD 14 million. Ignoring the haircut would overstate the protection and understate the exposure.
- AUSD 14 millionCorrect
- BUSD 10 million
- CUSD 6 million
- DUSD 4 million
Explanation
Adjusted collateral value = 40 x (1 - 0.10) = USD 36 million. Net exposure = 50 - 36 = USD 14 million. USD 10 million ignores the haircut, and USD 6 million wrongly applies the haircut upward (40 x 1.10 = 44; 50 - 44).
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