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Answer: P, Q, S, R
The question pertains to the calculation of net exposure for four derivative counterparties that have entered into bilateral netting arrangements. The provided exhibit lists the positive and negative mark-to-market (MtM) values for each pair of counterparties. The task is to determine the correct order of net exposure per counterparty from highest to lowest. To calculate the net exposure for each counterparty, we sum up the positive MtM trades and subtract the negative MtM trades for each pair of counterparties. Here's the breakdown: 1. **Counterparty P**: - With Q: \( 8 - 6 = 2 \) million - With R: \( 10 - 2 = 8 \) million - With S: \( 4 - 4 = 0 \) million - Total net exposure for P: \( 2 + 8 + 0 = 10 \) million 2. **Counterparty Q**: - With P: \( 15 - 16 = -1 \) (but since it's negative, it's considered 0) - With R: \( 6 - 0 = 6 \) million - With S: \( 7 - 8 = -1 \) (but since it's negative, it's considered 0) - Total net exposure for Q: \( 0 + 6 + 0 = 6 \) million 3. **Counterparty R**: - With P: \( 6 - 6 = 0 \) million - With Q: \( 4 - 5 = -1 \) (but since it's negative, it's considered 0) - With S: \( 8 - 12 = -4 \) (but since it's negative, it's considered 0) - Total net exposure for R: \( 0 + 0 + 0 = 0 \) million 4. **Counterparty S**: - With P: \( 2 - 2 = 0 \) million - With Q: \( 13 - 10 = 3 \) million - With R: \( 1 - 1 = 0 \) million - Total net exposure for S: \( 0 + 3 + 0 = 3 \) million The correct order of net exposure per counterparty, from highest to lowest, is therefore P (10 million), Q (6 million), S (3 million), and R (0 million), which corresponds to option A: P, Q, S, R. This question tests the understanding of netting's effectiveness in reducing credit exposure. By netting the positive and negative MtM trades, counterparties can significantly reduce their overall credit risk exposure. The example illustrates that netting can lead to a total net exposure of zero for one counterparty (R), while others have reduced exposures. This highlights the importance of netting arrangements in derivative transactions to manage and mitigate credit risk.
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Four derivative counterparties (P, Q, R, and S) have established bilateral netting agreements to manage their exposure. The table below provides a detailed summary of their bilateral mark-to-market (MtM) positions, expressed in USD millions, reflecting the current market values of their respective trades.
Mark-to-Market Trades for Four Counterparties (USD million)
| Opposing Counterparty | ||||
|---|---|---|---|---|
| Q | R | S | ||
| Counterparty P | Trades with positive MtM | 8 | 10 | 4 |
| Trades with negative MtM | -6 | -2 | -4 | |
| Counterparty Q | Trades with positive MtM | 15 | 6 | 7 |
| Trades with negative MtM | -16 | 0 | -8 | |
| Counterparty R | Trades with positive MtM | 6 | 4 | 8 |
| Trades with negative MtM | -6 | -5 | -12 | |
| Counterparty S | Trades with positive MtM | 2 | 13 | 1 |
| Trades with negative MtM | -2 | -10 | -1 |
Assuming comprehensive netting agreements are in place across all pairs of counterparties, determine the correct ranking of net exposure per counterparty, listed from highest to lowest, in the context of the Financial Risk Manager (FRM) examination.
A
P, Q, S, R
B
Q, R, S, P
C
R, Q, P, S
D
S, P, Q, R