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

A bank's xVA desk computes KVA for a long-dated derivatives book. Which best describes what KVA represents and its main input?

KVA is the cost of holding regulatory capital against derivative exposures over their life. It is calculated from projected capital requirements multiplied by the bank's hurdle rate on capital, then discounted. CVA covers expected counterparty default loss and DVA covers the bank's own default benefit.

  1. AThe cost of holding regulatory capital against the exposure over time, driven by projected capital requirements and the bank's hurdle rateCorrect
  2. BThe cost of funding variation margin, driven by overnight rates
  3. CThe expected loss from counterparty default, driven by recovery rates
  4. DThe benefit from the bank's own default, driven by its CDS spread

Explanation

KVA is the present value of the expected cost of holding capital to support the trades, using projected capital requirements multiplied by the required return on capital. The other options describe MVA/FVA, CVA, and DVA respectively.

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