Explanation:
Without Netting: The loss to the financial institution is the sum of the positive mark-to-market values (exposures) of the derivatives, as negative values simply terminate at zero cost upon counterparty default. Exposure = max(33, 0) + max(-22, 0) + max(8, 0) + max(-17, 0) Exposure = 33 + 0 + 8 + 0 = 41 million USD
With Netting: The loss is based on the net value of all derivative positions combined. Exposure = max(Sum of all positions, 0) Exposure = max(33 - 22 + 8 - 17, 0) = max(2, 0) = 2 million USD
Therefore, the loss if netting is used is 2 million USD, while the loss without netting is 41 million USD.
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Q.35 A Spanish bank has the following derivative positions with a local company:
| Position | Price (USD) |
|---|---|
| Long currency swaps | 33 million |
| Short credit default swaps | -22 million |
| Long interest rate swaps | 8 million |
| Short swaptions | -17 million |
In the event that the counterparty (company) defaults, what would be the loss to the financial institution if netting is used compared to the loss without netting?
A
| Loss if netting is used (USD) | Loss without netting (USD) |
|---|---|
| 2 million | 2 million |
B
| Loss if netting is used (USD) | Loss without netting (USD) |
|---|---|
| 2 million | 41 million |
C
| Loss if netting is used (USD) | Loss without netting (USD) |
|---|---|
| 41 million | 2 million |
D
| Loss if netting is used (USD) | Loss without netting (USD) |
|---|---|
| 29 million | 41 million |
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