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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

Under a legally enforceable netting agreement, Bank A has four trades with a defaulting counterparty, valued at close-out as +USD 18 million, +USD 7 million, -USD 12 million and -USD 5 million. No collateral is held. What is Bank A's claim on the defaulted counterparty, and the reduction in claim versus no netting?

Netting gives a claim of USD 8 million (18 + 7 - 12 - 5). Without netting the claim would be the sum of the positive trades, USD 25 million, so netting reduces the claim by USD 17 million.

  1. AClaim USD 8 million; reduction USD 17 millionCorrect
  2. BClaim USD 25 million; reduction USD 0
  3. CClaim USD 8 million; reduction USD 25 million
  4. DClaim USD 17 million; reduction USD 8 million

Explanation

Net = 18 + 7 - 12 - 5 = 8 million. Without netting, the claim is the sum of positive values = 25 million. Reduction = 25 - 8 = 17 million. Choice C mistakes the gross figure as the reduction.

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