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

Under the Basel III CVA capital framework, which statement about eligible hedges is correct?

Only hedges that are actually used to mitigate CVA risk and satisfy the eligibility criteria, such as single-name CDS on the counterparty, are recognised to reduce the CVA capital charge. Arbitrary CDS positions or hedges of other risks do not qualify, so the framework is not purely gross.

  1. AAny CDS reduces CVA capital regardless of the referenced name
  2. BOnly hedges that are used to mitigate CVA risk and meet eligibility criteria, such as single-name CDS on the counterparty, can be recognised to reduce the CVA risk capital chargeCorrect
  3. CCVA capital can be reduced by hedges of the CCR default risk exposure
  4. DHedges are never recognised, because CVA capital is calculated on a gross basis

Explanation

Basel recognises eligible hedges of CVA risk, such as single-name CDS on the counterparty and index CDS where criteria are met, to reduce the capital charge. Hedges not used for CVA risk mitigation or not meeting criteria are not recognised, so the claim that any CDS qualifies is wrong. Also, hedges are not ignored.

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