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FRM Part I · FRM Exam Part I · Central Clearing

Bank A and Bank B have three OTC derivatives under a single legally enforceable bilateral netting agreement. Mark-to-market values to Bank A are +USD 30 million, +USD 12 million and -USD 25 million. Ignoring collateral, if Bank B defaults, what is Bank A's credit exposure with close-out netting versus without netting?

With close-out netting, exposure is the net value of 30 plus 12 minus 25, which equals USD 17 million. Without netting, the bank is exposed on the positive contracts separately, 30 plus 12, or USD 42 million. Netting reduces exposure by offsetting negative values.

  1. AUSD 17 million with netting; USD 42 million without nettingCorrect
  2. BUSD 42 million with netting; USD 17 million without netting
  3. CUSD 17 million with netting; USD 17 million without netting
  4. DUSD 5 million with netting; USD 42 million without netting

Explanation

With netting, exposure is max(30+12-25, 0) = 17. Without netting, Bank A must still pay the -25 to the defaulted estate but only claims on the positive contracts, so exposure is 30+12 = 42. Option 3 ignores the netting benefit.

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