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

A dealer bank prices a new uncollateralised interest rate swap with a corporate client. In addition to the risk-free value, the trader adds a charge for the expected cost of funding the uncollateralised portion of the position, net of benefit from the position's negative exposure. Which valuation adjustment does this charge represent?

The charge is the funding valuation adjustment (FVA). It reflects the cost of funding the uncollateralised part of a derivative, net of funding benefits from negative exposure. CVA covers counterparty default, DVA the bank's own default, and KVA the cost of regulatory capital.

  1. AFunding valuation adjustment (FVA)Correct
  2. BCredit valuation adjustment (CVA)
  3. CCapital valuation adjustment (KVA)
  4. DDebit valuation adjustment (DVA)

Explanation

FVA captures the cost or benefit of funding derivatives that are not fully collateralised. CVA concerns counterparty default losses, DVA the bank's own default benefit, and KVA the cost of holding regulatory capital, so none of these describes a funding charge.

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