FRM Part I · FRM Exam Part I · Central Clearing
A clearing member has two OTC trades with the same counterparty, uncleared: Trade 1 has a mark-to-market value of +USD 18 million to the member and Trade 2 has -USD 11 million. Both are in a legally enforceable netting set. The member's counterparty then defaults. Ignoring collateral and recoveries, what is the member's credit exposure to the defaulter before and after netting?
Without netting, exposure counts only the positive-value trade, USD 18 million. With legally enforceable netting, the trades offset to a net positive value of USD 7 million. The USD 29 million figure wrongly adds the absolute values of both trades.
- ABefore netting USD 18 million, after netting USD 7 millionCorrect
- BBefore netting USD 29 million, after netting USD 7 million
- CBefore netting USD 7 million, after netting USD 18 million
- DBefore netting USD 18 million, after netting USD 18 million
Explanation
Without netting, the member loses only on positive-value trades, so exposure is max(18,0)+max(-11,0)=18. With netting, exposure is max(18-11,0)=7. The USD 29 million option adds absolute values, which is wrong since the negative trade is a liability.
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