FRM Part II · FRM Exam Part II · Derivatives
A bank uses the Basel standardised CVA approach and a risk manager observes that a portfolio of long-dated swaps with a lower-rated counterparty attracts a much higher CVA charge than short-dated swaps with the same notional and an investment-grade counterparty. Which factors explain this difference?
The standardised CVA charge depends on exposure, effective maturity and a supervisory weight tied to counterparty rating. Long-dated trades with a lower-rated counterparty have a higher weight and longer maturity, so CVA is more sensitive to spread changes and the capital charge is much larger.
- AOnly the counterparty's rating, because maturity does not enter the charge
- BHigher supervisory risk weight for the lower rating and greater effective maturity, which increases the exposure-weighted sensitivity to spreadsCorrect
- CLower exposure at default due to longer maturity amortisation
- DReduced capital because longer maturities allow more time for collateral to be called
Explanation
The standardised CVA charge scales with EAD, effective maturity (duration-like factor) and a supervisory weight that rises as credit quality falls. Long-dated trades from a weaker counterparty raise all three drivers, so sensitivity to spread moves is larger. Maturity does enter the formula, so the rating-only option is wrong.
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