- Revised Question
An investment bank's Chief Risk Officer (CRO) has tasked the risk department with evaluating the bank's derivative exposure to a counterparty over a 3-year period. The risk department assumes the counterparty's default probability follows a constant hazard rate process. The table below outlines trade and projected data on the Credit Default Swap (CDS) spread, the expected positive exposure, and the recovery rate of the counterparty:
| Year | Expected Positive Exposure (AUD million) | CDS Spread (bps) | Recovery Rate (%) |
|---|
| Year1 | 14 | 200 | 80 |
| Year2 | 14 | 300 | 70 |
| Year3 | 14 | 400 | 60 |
Additionally, the CRO has provided the risk team with the following assumptions for the analysis:
- The investment bank and the counterparty have established a credit support annex to mitigate exposure, requiring collateral posting of AUD 11 million.
- The prevailing risk-free interest rate is 3%, and the term structure of interest rates remains stable over the 3-year period.
- Both the collateral and the expected positive exposure values remain constant as projected over the 3-year term of the contract.
- Identical discount factors are used for evaluating the expected positive exposure and the collateral.
- The bank’s default probability is 0% per year.
Given the information and assumptions above, what is the precise calculation of the unilateral CVA (Credit Valuation Adjustment) for this position?
