P2.T6.207. Counterparty risk (credit exposure terminology)
206.1. Acme Bank is the counterparty to Downtown Dealer in three derivative contracts. Close-out netting applies to all contracts between the two counterparties. From Acme's perspective, the current contract values are:
1st contract: +4.0 million to Acme; i.e., Acme's is $4.0 million "in the money"
2nd contract: +2.5 million to Acme
3rd contract: -8.0 million; i.e., Acme owes $8.0 million to Downtown Dealer
What is Acme's net current (credit) exposure with respect to Downtown Dealer?
- $1.5 million
- $8.0 million
- $14.5 million
206.2. For a portfolio of derivative contracts, Analyst Jane wants to estimate her firm's counterparty exposure on a future target date, T(1), which is one year forward. For convenience, she assumes the future value of the portfolio at that time, T(1) has a normal distribution with a mean of zero (an equal likelihood of a gain/ITM or loss/OTM on the position) and standard deviation of $3.0 million. Of course, Jane realizes this is an unrealistic assumption and that a Monte Carlo simulation is unlikely to produce a forward normal distribution! Nevertheless, consider the following two statements:
I. The Expected Exposure, EE[T(1)], is equal to zero
II. The Potential Future Exposure, PFE[T(1)], is almost $7.0 million
Which is (are) true?
- I. is true
- II is true
- Both are true
206.3. Consider the exposure profile of a vanilla fixed-for-floating interest rate swap with a maturity (tenor) of five (5) years. Each of the following is true EXCEPT which is false?
- The expected positive exposure (EPE) must be LESS THAN the largest value among the set of expected exposures, EE(t1), EE(t2), etc
- The maximum potential future exposure (MPFE) is likely to occur after the fourth year due to the amortization effect
- Expected exposure is likely to be an increasing function for approximately the initial 1.5+ years the diffusion effect
- There will be several values of EE(t) and PFE(t) but only a single expected positive exposure (EPE) and a single potential future exposure (PFE)