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FRM Part II · FRM Exam Part II · Future Value and Exposure

A bank sold a 1-year European call option on a stock to a corporate client and received the full premium upfront. From the bank's perspective, what is the counterparty credit exposure to the client on this option over its life?

The bank's counterparty exposure is zero. Once the buyer has paid the premium in full, the seller only owes performance and has no amount receivable from the buyer, so the option has positive value only to the client, who bears the credit risk.

  1. APositive and equal to the option's market value
  2. BZero, because the bank has no claim on the client after receiving the premiumCorrect
  3. CEqual to the strike price times the number of shares
  4. DEqual to the premium received, declining linearly to zero

Explanation

After the premium is paid, the bank, as option seller, has only obligations to the client. Its mark-to-market is never positive from a receivable standpoint, so there is no counterparty exposure; the client bears the credit risk of the bank. Option value is a liability for the bank.

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