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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

A dealer has three OTC derivative trades with a single counterparty under a legally enforceable netting agreement. Mark-to-market values to the dealer are +USD 14 million, -USD 9 million and +USD 6 million. If the counterparty defaults, with no collateral held, what is the dealer's credit exposure compared with the exposure without netting?

With netting the dealer's exposure is the net value, 14 minus 9 plus 6, which is USD 11 million. Without netting, only the positive trades count as exposures, 14 plus 6, or USD 20 million. Netting therefore reduces the exposure by USD 9 million.

  1. AUSD 11 million with netting; USD 20 million without nettingCorrect
  2. BUSD 20 million with netting; USD 11 million without netting
  3. CUSD 11 million with netting; USD 5 million without netting
  4. DUSD 9 million with netting; USD 20 million without netting

Explanation

With netting, exposure is the sum of values: 14 - 9 + 6 = 11 million. Without netting, the dealer must still pay the -9 million trade but can recover only the positive trades: 14 + 6 = 20 million. Option with 20 and 11 reversed ignores that netting reduces exposure.

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