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CMA Final · Risk Management in Banking and Insurance · Operational Risk and Off-Balance Sheet Risk

Case: A bank has a forward contract with a customer to buy USD 1,00,000 at Rs 84 per USD. The current replacement cost (mark-to-market) is Rs 2,00,000 positive. The add-on factor for potential future exposure is 1.5% of notional, and notional is Rs 84,00,000. Under the current exposure method, the credit equivalent amount is:

The credit equivalent amount is Rs 3,26,000. Under the current exposure method it is the positive replacement cost of Rs 2,00,000 plus the add-on of 1.5% on notional of Rs 84,00,000, which is Rs 1,26,000. Using either component alone understates the exposure.

  1. ARs 1,26,000
  2. BRs 3,26,000Correct
  3. CRs 2,00,000
  4. DRs 2,84,000

Explanation

Potential future exposure = 1.5% x 84,00,000 = Rs 1,26,000. Credit equivalent = current replacement cost + add-on = 2,00,000 + 1,26,000 = Rs 3,26,000. Rs 1,26,000 omits the replacement cost, and Rs 2,00,000 omits the add-on.

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