The impact of changing recovery rate assumptions on the Credit Valuation Adjustment (CVA) is reasonably small. This is due to a cancellation effect: an increase in the recovery rate increases the implied default probability but reduces the resulting loss. In other words, while a higher recovery rate implies a higher likelihood of default, it also means that the loss incurred in the event of a default is reduced. This cancellation effect results in a relatively small impact on the CVA when recovery rate assumptions are changed.

Choice A is incorrect. The impact of changing actual and settled recovery rates on the CVA is not unreasonably big. While it's true that changes in recovery rates can influence the CVA, this influence is typically moderate and within reasonable bounds, reflecting the inherent uncertainty in estimating future recoveries.

Choice C is incorrect. The impact of changing actual and settled recovery rates on the CVA is not constant. Recovery rates are inherently uncertain and can fluctuate based on a variety of factors, including changes in economic conditions, industry trends, and specific counterparty circumstances. Therefore, their impact on the CVA will also vary over time.

Choice D is incorrect. It's inaccurate to describe the impact of changing actual and settled recovery rates on the CVA as insignificant. Although these changes may not drastically alter the overall risk profile of a portfolio or transaction, they do have a measurable effect on credit risk quantification through their influence on expected loss calculations.

Things to Remember

• Loss Given Default (LGD) is the percentage of exposure that is expected to be lost if the counterparty defaults.
• Recovery rate (R) is the complement of LGD, representing the percentage of exposure that is expected to be recovered in the event of counterparty default.
• The relationship between LGD and recovery rate is given by the formula LGD = 100% - R, indicating that if one increases, the other decreases.