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Explanation:
EE for no netting =
EE for netting =
Netting benefit = $11 - 1 = 10$
Negative future values have more netting benefits than positive future values.
Stronger negative MtM values offer more netting benefits. Let’s consider the MtM of trade 1 in scenario 1, i.e., -30. If this were to be paired with the positive MtMs under trade 2, it would totally offset two exposures > +15 and +5 in scenarios 2 and 3, respectively. In addition, it would offset +30 of +35 in scenario 1, leaving only a netted exposure of +5.
How about the MtM of -15 in scenario 3; how much power would it have over the positive MtMs of trade 2?
As in the first case above, a MtM of -15 would completely offset two exposures > +15 and +5. However, it would offset only +15 units out of +35 units in scenario 1, leaving behind a netted exposure of +20.
Clearly, therefore, a negative MtM of -30 is more useful and more beneficial to the netting set than a negative MtM of, say, -15 or -5.
It’s also correct to say that the more positive the MtM is, the higher its netting reduction power. Think about it intuitively. If you have a large positive, it means you’ll need as large a negative in order to attain a netting benefit. If you have a +50, for instance, you’ll need another trade with at least -50 in order to fully offset the exposure and reduce it to zero.
Finally, note that for an instrument to give any benefit from netting then there must be some chance of it having a negative MtM at some point in its lifetime. If the MtM of an instrument can only be positive, then it can never have a beneficial impact on the overall exposure (although other trades may be considered to reduce its own exposure).
Q.1942 From the following table, find the netting benefit along with an interpretation:
| Future Value Trade 1 | Trade 2 | Total No Netting | Exposure Netting | |
|---|---|---|---|---|
| Scenario 1 | –30 | 35 | 35 | 5 |
| Scenario 2 | –25 | 15 | 15 | 0 |
| Scenario 3 | –15 | 5 | 5 | 0 |
| Scenario 4 | –25 | –25 | 0 | 0 |
| Scenario 5 | –15 | –15 | 0 | 0 |
| EE | ? | ? |
A
5; negative future values have less netting benefits than positive future values
B
10; negative future values have less netting benefits than positive future values
C
5; negative future values have more netting benefits than positive future values
D
10; negative future values have more netting benefits than positive future values
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