FRM Part II · FRM Exam Part II · Credit Value Adjustment
A bank trades with a single counterparty under a legally enforceable netting agreement. Two trades have mark-to-market values of +USD 12 million and -USD 5 million to the bank. Ignoring collateral, what is the bank's current exposure to the counterparty if the counterparty defaults?
The exposure is USD 7 million, because enforceable close-out netting lets the bank offset the USD 5 million negative trade against the USD 12 million positive trade. Without netting the exposure would be USD 12 million, so netting reduces credit exposure and, in turn, CVA.
- AUSD 7 millionCorrect
- BUSD 12 million
- CUSD 17 million
- DUSD 5 million
Explanation
With enforceable netting, the positive and negative values offset: 12 - 5 = 7 million. Without netting the exposure would be 12 million (the sum of positive values only), which is the key wrong choice. Adding absolute values (17) is meaningless as exposure.
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