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Answer: The interest rates have an implied drift.
C is correct. When there are drifts in the market variables, for instance, forward rates being significantly different from spot rates, then future value for a given portfolio can be higher or lower. A is incorrect. The bank's default intensity (probability of default) does not impact its estimation of EFV of counterparty positions, it only affects the default event indicator. B is incorrect. Asymmetric cash flows are consistent with variation in EFV. Symmetry implies that the EFV is always zero. D is incorrect. The distribution of future values does not require a normal distribution assumption and does not explain variation in EFV. Even if the distribution of future values (such as CDS) is a normal distribution, it can be stationary such that its expected value is constant over time (rather than varying).
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The head of the CVA desk at an investment bank asks an analyst to report on the factors that have the potential to impact the estimation of counterparty exposure metrics. The analyst focuses on the expected future value (EFV) metric which the CVA desk typically uses for estimating the unilateral CVA (UCVA) for cross-currency counterparty positions. The analyst finds several factors that cause the EFV to vary significantly from its current value. Which of the following correctly explains EFV variations?
A
The default intensity of the investment bank tends to change.
B
The cash flows in the transactions tend to be symmetric.
C
The interest rates have an implied drift.
D
The distribution of future values requires a normal distribution assumption.
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