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

A risk manager compares counterparty credit risk with the credit risk of a standard loan. Which statement correctly describes a key difference?

Counterparty exposure on a derivative is uncertain because it depends on future market values and is floored at zero, while a loan exposure is essentially the known principal outstanding. Derivative exposure can also switch between positive and negative, making it bilateral in nature.

  1. ACounterparty exposure is uncertain and can be positive or zero depending on future market values, whereas loan exposure is largely the known notional amountCorrect
  2. BCounterparty exposure is always equal to the notional amount of the derivative, as with a loan
  3. CLoan exposure is bilateral because either party can lose, whereas derivative exposure is unilateral
  4. DCounterparty risk arises only at contract inception and falls to zero afterwards

Explanation

A derivative's value moves with market factors, so the future exposure is stochastic and floored at zero, and risk can be two-sided. A loan's exposure is mostly the known principal. Notional is not the exposure for derivatives.

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