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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A bank's trading desk argues that FVA should not be charged to clients because funding costs are a treasury matter, and that charging them breaches the law of one price. Which counter-argument is most consistent with the XVA literature discussed in counterparty risk practice?

The strongest counter-argument is that uncollateralised derivatives impose real funding costs on the bank, so ignoring them mispricing trades and invites arbitrage against the bank. FVA is not zero, is distinct from CVA, and is not limited to cleared trades.

  1. AUncollateralised derivatives create real funding costs for the bank, so ignoring them leads to mispricing and arbitrage against the bankCorrect
  2. BFunding costs equal the risk-free rate, so FVA is always zero
  3. CFVA is fully captured by CVA, so a separate charge would double count with no exceptions
  4. DFVA only applies to centrally cleared trades where initial margin is posted

Explanation

Practitioners charge FVA because uncollateralised trades must be funded at the bank's actual cost, and ignoring it lets other participants exploit mispricing. Academics dispute it, but the practical rationale is real funding cost. Funding is not at the risk-free rate, and FVA is distinct from CVA, though some overlap exists with DVA.

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