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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A bank prices an uncollateralised interest rate swap with a corporate client. Besides CVA and DVA, the trading desk adds a charge to reflect the cost of funding the positive expected exposure on the swap when the bank cannot rehypothecate collateral against it. Which valuation adjustment does this charge represent?

The charge is a funding valuation adjustment (FVA). FVA reflects the cost of funding the positive exposure of uncollateralised derivatives at the bank's funding spread over the risk-free rate. KVA covers capital costs, MVA covers initial margin funding, and DVA covers the bank's own default risk.

  1. AFunding valuation adjustment (FVA)Correct
  2. BCapital valuation adjustment (KVA)
  3. CMargin valuation adjustment (MVA)
  4. DDebit valuation adjustment (DVA)

Explanation

FVA captures the cost (or benefit) of funding uncollateralised derivative positions at the bank's own funding spread above the risk-free rate. KVA concerns the cost of holding regulatory capital, MVA concerns funding initial margin, and DVA reflects the bank's own default risk.

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