Skip to content

FRM Part II · FRM Exam Part II · Derivatives

A bank holds an uncollateralized interest rate swap with a corporate client. The swap currently has a mark-to-market value of -USD 3 million to the bank. Which statement best describes the bank's current exposure to the client on this trade?

Current exposure is the greater of the trade's mark-to-market value and zero. Because the swap is worth negative USD 3 million to the bank, its exposure is zero, as the bank owes the counterparty rather than being owed. Only positive value represents a potential loss on default.

  1. AUSD 3 million, because exposure equals the absolute value of the swap
  2. BZero, because the bank would owe money to the client and so would lose nothing on defaultCorrect
  3. CUSD 3 million, because the bank must pay the client on default
  4. DNegative USD 3 million, which reduces exposure on other trades automatically

Explanation

Current exposure is max(V, 0). With V = -3 million, exposure is 0 for this trade. The bank would still owe the value to the defaulted client's estate, but it has no claim to lose. The absolute-value option confuses exposure with notional-style size. Netting offsets would only apply if a netting agreement covers other trades.

Did you get it right without looking?

One question tells you little. A timed set on Derivatives shows your real accuracy, how long you take and where you lose marks.

Practise DerivativesFree diagnostic mock

More Derivatives questions