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Answer: Global Bank requests an increase in the CVA charge it receives.
## Explanation This question involves Credit Value Adjustment (CVA) and how credit rating changes affect CVA charges between counterparties. ### Key Analysis: **Credit Spread Changes:** - **Global Bank**: Increased from 20 bps to 150 bps (+130 bps increase) - **Local Company**: Increased from 130 bps to 170 bps (+40 bps increase) **Rating Changes:** - **Global Bank**: AA+ → A (significant downgrade) - **Local Company**: A → A- (minor downgrade) ### CVA Logic: CVA represents the market value of counterparty credit risk. When a counterparty's credit quality deteriorates: - The CVA charge **increases** for the party facing that counterparty - The party with improved relative credit quality would request higher CVA charges ### Why Option B is Correct: 1. **Global Bank experienced a much larger credit deterioration** (130 bps increase vs 40 bps for Local Company) 2. **Global Bank's credit spread increased more dramatically** from a very low level (20 bps) to a much higher level (150 bps) 3. **Local Company's relative credit position improved** compared to Global Bank 4. Therefore, **Global Bank would request higher CVA charges** to compensate for its increased counterparty risk exposure to Local Company ### Why Other Options are Incorrect: - **A**: The changes are significant enough to warrant CVA adjustments - **C**: Local Company's credit deteriorated (though less than Global Bank), so it wouldn't request lower charges - **D**: CVA remains highly relevant for swap counterparty risk management **Answer: B** - Global Bank requests an increase in the CVA charge it receives.
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Local Company, a frequent user of swaps, often enters into transactions with Global Bank, a major provider of swaps. Recently, Global Bank was downgraded from a rating of AA+ to a rating of A, while Local Company was downgraded from a rating of A to a rating of A-. During this time, the credit spread for Global Bank increased from 20 bps to 150 bps. While the credit spread for Local Company increased from 130 bps to 170 bps. Which of the following is the most likely action that the counterparties will request on their credit value adjustment (CVA)?
A
The credit qualities of the counterparties have changed, but not enough to justify amending existing CVA arrangements.
B
Global Bank requests an increase in the CVA charge it receives.
C
Local Company requests a reduction in the CVA charge it pays.
D
CVA is no longer a relevant factor, and the counterparties will use other mitigants of counterparty risk.