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

A bank's derivative book with a counterparty has a unilateral CVA of USD 2.40 million (loss from counterparty default) and a DVA of USD 0.90 million (gain from the bank's own default). The bank's own credit spread then widens sharply, doubling DVA, while the counterparty's credit is unchanged. What is the change in reported bilateral CVA (CVA minus DVA) and its effect on earnings, ignoring other factors?

Bilateral CVA falls from USD 1.50 million to USD 0.60 million, giving a USD 0.90 million accounting gain. Doubling DVA to 1.80 million lowers the net charge, so the bank books a profit as its own credit deteriorates, the counterintuitive DVA effect.

  1. ABilateral CVA falls from USD 1.50 million to USD 0.60 million, producing an accounting gain of USD 0.90 millionCorrect
  2. BBilateral CVA rises from USD 1.50 million to USD 2.40 million, producing a loss of USD 0.90 million
  3. CBilateral CVA falls from USD 3.30 million to USD 0.60 million, producing a gain of USD 2.70 million
  4. DBilateral CVA is unchanged because DVA does not depend on the bank's spread

Explanation

Initial bilateral CVA = 2.40 - 0.90 = 1.50. DVA doubles to 1.80, so bilateral CVA = 2.40 - 1.80 = 0.60. The reduction of 0.90 is a gain, even though the bank's creditworthiness deteriorated, which is the well-known counterintuitive DVA effect.

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