FRM Part II · FRM Exam Part II · Derivatives

A risk analyst computes a bank's CVA to a counterparty assuming independence between exposure and default. The expected exposure at the single relevant date is 20 million, the default probability over the period is 4%, and LGD is 60%, giving CVA of 0.48 million. Evidence suggests conditional on default, the expected exposure would be 30 million. Using the conditional exposure, what is the adjusted CVA?

The adjusted CVA is 0.72 million. Under wrong-way dependence the relevant exposure is that conditional on default, 30 million, so CVA is 30 times 4% times 60%. The independence-based 0.48 million understates the loss.

A0.48 million
B0.72 millionCorrect
C1.20 million
D0.30 million

Explanation

With wrong-way dependence, use expected exposure conditional on default: 30 × 4% × 60% = 0.72 million. The independent figure 20 × 0.04 × 0.6 = 0.48 million understates it. 1.20 million would omit LGD scaling errors such as 30 × 4%; 0.30 is not derived from the data.

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