FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk
A bank lends USD 10 million to a corporate borrower and holds collateral of marketable bonds worth USD 10 million. Under a haircut approach, the bonds receive a 15% haircut for price volatility. Assuming default, what is the bank's uncollateralised exposure after haircut, ignoring exposure add-ons?
The haircut reduces the collateral's recognised value to USD 8.5 million (10 million times 0.85). Subtracting from the USD 10 million loan leaves an uncollateralised exposure of USD 1.5 million, which reflects the risk that collateral value falls before liquidation.
- AUSD 0
- BUSD 1.5 millionCorrect
- CUSD 8.5 million
- DUSD 11.5 million
Explanation
Adjusted collateral value = 10 x (1 - 0.15) = 8.5 million. Remaining exposure = 10 - 8.5 = 1.5 million. Option 8.5 is the collateral value, not the exposure; 11.5 wrongly adds the haircut to the exposure side.
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