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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A risk manager is assessing how the margin period of risk (MPOR) affects CVA for a collateralised portfolio. The firm moves from daily margining with a 10-business-day MPOR to a counterparty agreement where disputes and slower operations lengthen the MPOR to 20 business days. Assuming exposure changes follow a random walk with constant volatility, what is the approximate effect on the collateralised exposure and CVA?

Exposure and CVA rise by roughly 41%. The value change that can accumulate during the margin period of risk scales with the square root of its length under random-walk assumptions, and the square root of 20 over 10 is about 1.41. Doubling would require linear scaling, which is not appropriate.

  1. AExposure and CVA rise by roughly 41%, as they scale with the square root of the MPORCorrect
  2. BExposure and CVA double, as they scale linearly with the MPOR
  3. CExposure and CVA are unchanged because collateral is exchanged daily
  4. DExposure and CVA fall because longer periods allow more netting

Explanation

Under random-walk dynamics, the potential exposure change over the MPOR scales with its square root, so the ratio is sqrt(20/10) = 1.414, about a 41% increase. Linear scaling would incorrectly double it. Call frequency does not remove the exposure that can build during the close-out period.

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