Answer: Loss of USD 20 million if netting is used; loss of USD 44 million if netting is not used

The correct answer is B. Netting refers to the process of offsetting the amounts owed between two parties in a financial transaction. In this scenario, the financial institution has four derivative positions with an investment company, with varying market values. When netting is applied, the institution considers the net position of these derivatives rather than their individual values. With netting, the financial institution's loss is calculated by summing the positive exposures and subtracting the negative exposures: - Long swaptions: +32 million USD - Long credit default swaps: +12 million USD - Long currency derivatives: -16 million USD - Long futures contracts: -8 million USD The net loss with netting is therefore: \( 32 million + 12 million - 16 million - 8 million = 20 million USD \) Without netting, the institution would have to consider the full value of the long positions, as if each were a separate loss: - Long swaptions: 32 million USD - Long credit default swaps: 12 million USD The total loss without netting would be: \( 32 million + 12 million = 44 million USD \) Thus, netting significantly reduces the financial institution's potential loss from 44 million USD to 20 million USD in the event of the investment company's default. This demonstrates the effectiveness of netting in credit risk management by reducing credit exposure and potential losses.

Author: LeetQuiz Editorial Team