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Answer: Loss of USD 20 million if netting is used; loss of USD 44 million if netting is not used
**B is correct.** **With Netting:** - Netting means that payments between counterparties are netted out, so only a net payment has to be made - Calculation: USD 32 million + USD 12 million - USD 16 million - USD 8 million = USD 20 million - The financial institution would lose USD 20 million **Without Netting:** - Without netting, the investment firm is required to make every payout on the long positions - Only the outstanding long positions are considered: USD 32 million + USD 12 million = USD 44 million - The financial institution would lose USD 44 million **Key Concept:** Netting reduces credit exposure by allowing offsetting positions to cancel each other out, while without netting, each position is treated separately and only the positive exposures are considered.
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A financial institution has four open derivative positions with an investment company. A description of the positions and their current market values are displayed in the table below:
| Position | Exposure (USD) |
|---|---|
| Long swaptions | 32 million |
| Long credit default swaps | 12 million |
| Long currency derivatives | -16 million |
| Long futures contracts | -8 million |
If the investment company defaults, what would be the loss to the financial institution if netting is used compared to the loss if netting is not used?
A
Loss of USD 20 million if netting is used; loss of USD 24 million if netting is not used
B
Loss of USD 20 million if netting is used; loss of USD 44 million if netting is not used
C
Loss of USD 24 million if netting is used; loss of USD 32 million if netting is not used
D
Loss of USD 20 million if netting is used; loss of USD 24 million if netting is not used
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