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Nicole Seaman

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Learning objectives: Identify factors that affect the calculation of the credit exposure profile and summarize the impact of collateral on exposure. Identify typical credit exposure profiles for various derivative contracts and combination profiles.


910.1. Consider credit exposure profiles for the following six positions:

I. A fixed-payer in a vanilla interest rate swap (IRS) with five years to maturity​
II. A position in a cross-currency swap (CCS) with five years to maturity​
III. A long position in a call option with five years to expiration​
IV. A short position (aka, written or sold) in a call option with five years to expiration​
V. A long position in a credit default swap (CDS; aka, protection buyer) with a five-year life​
VI. A short position in a credit default swap (CDS; aka, protection seller) with a five-year life​

All of these positions mature in five years. For which of these position(s) is the expected exposure at the five year horizon, EE(+ 5.0 years), likely to be greater than 3.0% of notional? (Bonus: same question for 9X.0% PFE)

a. II (long cross-currency swap) and III (long call option) only
b. IV (short call option) and VI (short CDS) only
c. I (fixed-payer IRS), II (CCS), IV (short call option), and V (long CDS)
d. All six positions

910.2. In the case of a cross-currency swap, which of the following dynamics has a tendency to DECREASE both expected exposure (EE) and potential future exposure (PFE)?

a. Longer maturity
b. Higher foreign exchange (FX) volatility
c. Paying (receiving) in the currency with a lower (higher) interest rate
d. Higher correlation between the two interest rates and the foreign exchange (FX) rate

910.3. Credit exposure profiles vary according to the instrument and, as Gregory writes, "can be substantially altered due to the specific nature of the cashflows in a transaction." With respect to credit exposure profiles, which of the following statements is TRUE?

a. Similar to market value at risk (mVaR), in most use cases of the quantification of counterparty credit exposure (aka, xVa), we can safely assume the drift of the risk factor is zero
b. In the case of a single-name credit default swap (CDS), expected exposure (EE) is generally a decreasing function with higher spread volatility
c. In the case of an interest rate swap (IRS), if the yield curve is upward-sloping, the floating-rate payer counterparty perceives a positive expected future value (EFV) and has the greater credit exposure
d. In the case of a simple forward contract, if the returns of the underlying market variable (e.g. FX) are independently identically distributed (i.i.d.), then the profile of a simple forward contract (i.e., a single CF) is approximately proportional (∝) to the square root of time

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