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FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk

A bank holds USD 50 million of bonds as collateral against a loan of USD 45 million. The supervisory haircut on the bonds is 10%, and the bank applies no haircut for currency mismatch because the currencies match. Using the simple collateral adjustment approach, what is the net exposure after collateral, ignoring haircut on the exposure itself?

The net exposure is zero. The USD 50 million of bonds is reduced by the 10% haircut to USD 45 million, which exactly equals the loan. The haircut protects against a fall in collateral value, so only the discounted value offsets the exposure.

  1. AUSD 0Correct
  2. BUSD 5 million
  3. CUSD 10 million
  4. DUSD 45 million

Explanation

Collateral value after haircut = 50 x (1 - 0.10) = USD 45 million. Net exposure = 45 - 45 = 0. Ignoring the haircut gives a USD 5 million excess, and subtracting the haircut incorrectly would give other figures.

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