Explanation:
If netting is NOT used, the exposure to the counterparty is the sum of the positive mark-to-market (MTM) values only, as negative MTM contracts still have to be honored (or will be settled in bankruptcy). Loss without netting = max(0, 33) + max(0, -22) + max(0, 8) + max(0, -17) = 33 + 0 + 8 + 0 = 41 million USD.
If netting is used, the exposure is the max of zero and the net sum of all positions. Loss with netting = max(0, 33 - 22 + 8 - 17) = max(0, 41 - 39) = 2 million USD.
Therefore, the loss with netting is 2 million USD and 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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