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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, with current values to the dealer of +USD 18 million, −USD 11 million and +USD 5 million. All trades are covered by a legally enforceable netting agreement. If the counterparty defaults, what is the dealer's exposure, and how does it compare with the exposure without netting?

With enforceable netting, the exposure is the net of all trade values: 18 minus 11 plus 5, or USD 12 million. Without netting it is the sum of the positive-value trades, USD 23 million. Netting therefore cuts exposure by the USD 11 million negative-value trade.

  1. AUSD 12 million with netting, versus USD 23 million without nettingCorrect
  2. BUSD 23 million with netting, versus USD 12 million without netting
  3. CUSD 12 million with netting, versus USD 12 million without netting
  4. DUSD 34 million with netting, versus USD 23 million without netting

Explanation

With netting the exposure is the net value: 18 − 11 + 5 = 12 million. Without netting the dealer must pay its liability yet claim only a share of its positive-value trades, giving an exposure equal to the sum of positive values: 18 + 5 = 23 million. Netting reduces exposure by 11 million.

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