Explanation

This question involves understanding the concept of netting in credit risk management. Netting allows financial institutions to offset positive and negative exposures when calculating credit exposure to a counterparty.

Key Concepts:

• Without netting: Each transaction is treated separately, and the financial institution would lose the full amount owed to them by the defaulting counterparty
• With netting: Positive and negative exposures are netted, resulting in a single net exposure amount

Analysis:

• Option B shows a loss of USD 20 million with netting and USD 44 million without netting
• This represents a significant reduction in exposure when netting is applied (USD 24 million reduction)
• The difference between the two scenarios (USD 44M - USD 20M = USD 24M) represents the amount that was offset through netting

Why Option B is correct:

• The USD 20 million loss with netting represents the net exposure after offsetting positive and negative positions
• The USD 44 million loss without netting represents the gross exposure where all positive positions are lost
• This demonstrates the risk mitigation benefit of netting arrangements in reducing credit exposure

Practical Application: Netting is particularly important in derivatives trading and other financial contracts where parties have multiple offsetting positions with the same counterparty. It reduces counterparty credit risk and is a key component of modern risk management practices.