Explanation:
CVA is the present value of the expected cost to a bank due to a counterparty's potential default and is subtracted from the no-default value, thus decreasing the value of the bank's derivatives portfolio. Conversely, DVA is the present value of the expected gain to the bank due to its own default from the counterparty's perspective and is added to the no-default value from the bank's perspective, increasing the value of the counterparty's derivatives portfolio.
A is incorrect. CVA represents a potential loss, not a gain, due to the counterparty's default. Therefore, it does not increase the value of the bank's portfolio. Conversely, DVA reflects the potential gain to the bank from its own default and increases the portfolio value, not decreases it.
C is incorrect. While it is true that CVA accounts for the risk of loss from the counterparty's potential default, it decreases, not increases, the value of the bank's portfolio. DVA does have an influence; it increases the bank's portfolio value by reflecting the potential gain to the bank if it defaults.
D is incorrect. DVA does not decrease the value of the bank's portfolio; it actually increases it by reflecting the potential gain to the bank in the event of its own default.
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Q.6060 As part of an advanced financial risk management seminar, an FRM candidate is required to explain the nuances of Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA). The candidate must accurately describe how these adjustments influence a bank's derivatives portfolio valuation. Which of the following statements is correct concerning the impact of CVA and DVA on the value of the derivatives portfolio?
A
CVA increases the value of the bank's portfolio by accounting for the potential gain due to the counterparty's default, while DVA decreases it by considering the bank's own default risk.
B
CVA decreases the value of the bank's portfolio by adjusting for the risk of counterparty default, and DVA increases it by considering the potential gain from the bank's own default.
C
CVA increases the value of the bank's portfolio due to the risk of loss from the counterparty's potential default, and DVA has no influence since it only affects the counterparty's portfolio.
D
Both CVA and DVA decrease the value of the bank's portfolio since they both adjust for the losses expected from defaults by the counterparty and the bank, respectively.