Hi David,

How does simple transaction method does not incorporate netting and offsetting.?

i can understand simple porfolio effect but not able to understand netting and offsetting concept.because even for simple transaction we take every transaction into account.

does author mentions it in respect of calculating potential exposure in terms of one number(simplest transaction method)?

plz explain where i am wrong.

Anil

Hi Anil,

Jorion gives the example of two counterparty contracts: one with positive value (i.e., exposure, the counterparty owes) of $100 million and another of negative $80 million (not exposure, but rather an obligation to the counterparty). Under simple, without netting, the exposure is $100 million because the bank does would not get to net the $80 MM against the $100 MM (although it is a pretty standard feature).

Offsetting is when transactions/contracts will move in different directions so, again, the “simple” method of adding exposures will overstate.

Mathematically, if the value of the different contracts/transactions separately is:
A, B, C, D

And if the exposures are, say,

+A, -B, +C, -D

Simple, without netting will say our exposure = A + C

But, if the contracts are all with the same counterparty, netting will reflect our true exposure as: A+B-C-D

Offsetting is not contractual but rather, if it’s true that A & C are negatively correlated, then simple A+C will also overstate the exposure

Hope that helps. David

Thanks David ,

dont know where in the world i was when i was reading this topic,even in case of STM i was taking netting into account.didnt nead your notes properly.

“Requires inherently uncertain approximations of potential increase in value”

Anil

Ha, Anil, you are a genius if you can understand some of these reading on the first pass. Seriously, a few of these readings I only feel like i started to grasp after 2-3 years...David

Thanks David,

that was encouraging for a person like me who is totally new to finance.

Anil