Explanation:
Current credit exposure is the positive market value of the swap to the bank.
Immediately after the initial exchange, Bank B has no positive exposure:
So the current exposure of Bank B is zero.
Among the choices, B is the best match because it correctly identifies that Bank A has the exposure, not Bank B.
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Question 1.4. Current exposure of Bank B in a cross-currency swap
Consider Bank A that enters into a cross-currency swap with Bank B. Under the terms of the swap, Bank A receives interest at 4.0% per annum in US dollars (USD) once per year on a principal of $100 million. In exchange, Bank A pays interest at 7.0% per annum in euros (EUR) once per year on a principal of EUR 70 million (i.e., Bank B will receive interest payments in euros, and Bank B’s financial principal will be received in Euros). Immediately after the initial exchange of principal, when the spot currency exchange rate is EUR/USD $1.40 (i.e., $1.40 USD per unit EUR), what is the current exposure of (a.k.a., credit exposure or current credit exposure) of Bank B?
A
Zero, because swap contract features require the initial swap value to be zero
B
Zero, because Bank A has the current exposure
C
negative (-) $2 million
D
positive (+) $2 million