Explanation:
Trade compression reduces counterparty risk by netting offsetting positions. Let's analyze the positions:
Digital Corporation → NUMU Inc.
Digital Corporation → WKI Company
WKI Company → NUMU Inc.
NUMU Inc. positions:
WKI Company positions:
After compression, the bank has:
However, the question asks for the net contract on compressed trades only, which refers to the net position after offsetting. The EUR 2 million represents the net position after offsetting the NUMU Inc. trades.
Correct Answer: B (EUR 2 million) - This represents the net position on NUMU Inc. after offsetting the long and short protection positions.
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The head of the structured securities desk at an investment bank directs all derivatives traders on the desk to use trade compressions on all eligible trades to reduce counterparty risk. One of the analysts decides to use trade compression on a portfolio of single-name CDS contracts with the same maturity and transacted with two counterparties to estimate the investment bank's compressed notional value:
| Counterparty | Reference credit | Notional (EUR million) | Bank's position | Coupon (bps) |
|---|---|---|---|---|
| Digital Corporation | NUMU Inc. | 9 | Long protection | 180 |
| Digital Corporation | WKI Company | 6 | Long protection | 150 |
| WKI Company | NUMU Inc. | 7 | Short protection | 150 |
What is the notional value of the investment bank's net contract on compressed trades only?
A
EUR 1 million
B
EUR 2 million
C
EUR 8 million
D
EUR 15 million