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Answer: CVA increases; DVA decreases.
## Explanation **CVA (Credit Valuation Adjustment)** represents the market value of counterparty credit risk - the risk that the counterparty will default and fail to make required payments. CVA increases when: - Counterparty credit spread widens (increased default probability) - Expected Positive Exposure (EPE) increases **DVA (Debit Valuation Adjustment)** represents the institution's own credit risk - the benefit from the possibility that the institution itself might default. DVA decreases when: - The institution's own credit spread widens (increased default probability) - Expected Negative Exposure (ENE) remains unchanged or decreases **Analysis of the scenario:** 1. **Counterparty credit spread widens** → Increases CVA 2. **FI's credit spread widens** → Decreases DVA (higher probability the FI will default, reducing the value of its liabilities) 3. **EPE increases** → Increases CVA (higher potential exposure to counterparty default) 4. **ENE remains unchanged** → No offsetting effect on DVA Therefore, under these conditions: - **CVA increases** due to wider counterparty credit spread and higher EPE - **DVA decreases** due to wider FI credit spread **Correct answer: A - CVA increases; DVA decreases**
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risk and the institution’s own credit risk, respectively. Under market stress, changes in credit spreads and exposures can impact these adjustments. During a market stress event:
How do the FI’s CVA and DVA change under these conditions?
A
CVA increases; DVA decreases.
B
CVA increases; DVA increases.
C
CVA increases; DVA remains unchanged.
D
CVA decreases; DVA increases.
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