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FRM Part II · FRM Exam Part II · Derivatives

A bank trades OTC derivatives with a corporate client. Under the Basel framework, the capital charge for the risk that the counterparty's creditworthiness deteriorates (mark-to-market losses on expected CVA) without actual default is best described as which of the following?

The CVA risk capital charge covers mark-to-market losses from deteriorating counterparty creditworthiness short of default. Basel III added it because many crisis losses came from CVA volatility. The default risk charge applies only to actual default losses on the exposure at default.

  1. ADefault risk capital charge on the exposure at default
  2. BCVA risk capital chargeCorrect
  3. CSettlement risk charge
  4. DLarge exposure buffer

Explanation

Basel III introduced a CVA capital charge to cover mark-to-market losses from changes in counterparty credit spreads, which were a major source of losses in the crisis. The default risk charge covers only losses from actual default, so it does not capture this volatility in credit valuation.

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