FRM Part I · FRM Exam Part I · Measuring Credit Risk
A bank lends USD 50 million and receives collateral worth USD 40 million. The collateral is subject to a 10% haircut. Ignoring other adjustments, what is the bank's net exposure after collateral?
The collateral is reduced by the 10% haircut to USD 36 million, so the net exposure is USD 50 million minus USD 36 million, or USD 14 million. Ignoring the haircut would wrongly give USD 10 million.
- AUSD 10 million
- BUSD 14 millionCorrect
- CUSD 6 million
- DUSD 4 million
Explanation
The haircut collateral value is 40 x (1 - 0.10) = USD 36 million. Net exposure = 50 - 36 = USD 14 million. USD 10 million ignores the haircut. USD 6 million adds the haircut to collateral (44). USD 4 million subtracts the haircut value from the loan incorrectly (50 - 36 mistaken for 40 - 36).
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