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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A bank trades an uncollateralised swap with a client. Expected positive exposure (EPE) is USD 10 million and expected negative exposure (ENE) is USD 6 million, both constant over a 2-year life, with zero discounting. The client's cumulative default probability over 2 years is 4% and the bank's is 2%. Both recovery rates are 40%, and exposure is independent of default. Ignoring joint default effects, what is the approximate bilateral CVA (net charge)?

The bilateral CVA is about USD 0.168 million. Unilateral CVA is 10 million x 4% x 60% = 0.24 million, DVA is 6 million x 2% x 60% = 0.072 million, and the net charge is their difference.

  1. AUSD 0.12 millionCorrect
  2. BUSD 0.168 million
  3. CUSD 0.240 million
  4. DUSD 0.072 million

Explanation

CVA = 10 x 4% x 60% = 0.24 million. DVA = 6 x 2% x 60% = 0.072 million. Bilateral = 0.24 - 0.072 = 0.168 million. So the net charge is USD 0.168 million. The 0.12 option wrongly mixes the figures and 0.24 ignores DVA.

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