Explanation:
Under Basel I, the Risk-Weighted Asset (RWA) for an OTC derivative is found by first calculating the Credit Equivalent Amount (CEA), which is the sum of the replacement cost (if positive) and the add-on amount.
$4,500,000.$100,000,000 × 0.5% = $500,000.$4,500,000 + $500,000 = $5,000,000.Under Basel I rules, OTC derivatives were subject to a maximum risk weight of 50%, even if the counterparty is a corporation (which normally has a 100% risk weight).
Therefore, RWA = CEA × 50% = $5,000,000 × 50% = $2,500,000.
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Q.41 Family Bank has entered a $100 million interest rate swap with a corporation. The swap has a remaining maturity of five years. The current value of the swap is $4.5 million. The table below gives add-on factors as a percentage of principal for derivatives.
| Time remaining to maturity | Interest rate | Equity |
|---|---|---|
| < 1 year | 0.0 | 6.0 |
| 1 to 5 years | 0.5 | 8.0 |
| > 5 years | 1.5 | 10.0 |
Based on the table above, the equivalent risk-weighted asset (RWA) under Basel I is closest to:
A
$5,000,000
B
$1,125,000
C
$3,500,000
D
$2,500,000
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