FRM Part II · FRM Exam Part II · Derivatives
A risk manager computes CVA assuming exposure and counterparty default are independent. Expected exposures at two dates are 10 at year 1 and 20 at year 2, with marginal default probabilities of 2% and 3%, LGD of 60%, and discounting ignored. Independent CVA is 0.60 × (10×0.02 + 20×0.03) = 0.48. Under wrong-way risk, expected exposure conditional on default is 1.5 times the unconditional value at both dates. What is CVA?
CVA is 0.72. Conditional exposures are 15 and 30, giving 0.3 plus 0.9 of exposure-weighted default probability, which is 1.2. Multiplying by the 60% loss given default yields 0.72, higher than the independent figure of 0.48.
- A0.72Correct
- B0.48
- C0.96
- D0.32
Explanation
Independent CVA = 0.6 × (0.2 + 0.6) = 0.48. Conditional exposures are 15 and 30: 15×0.02 = 0.3 and 30×0.03 = 0.9, sum 1.2, times 0.6 = 0.72. The 0.48 option ignores the wrong-way adjustment.
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