Credit Risk Management Counterparty Credit Risk 2

Question 1

Which of the following is a key advantage of central clearing through a Central Counterparty (CCP) for OTC derivatives?

Accepted Answer

Reduction of bilateral counterparty credit risk through multilateral netting and default management

Answer

Elimination of all market risk in the cleared portfolio

Answer

Removal of margin requirements for cleared transactions

Answer

Transfer of legal documentation risk to the CCP

Question 2

Debit Value Adjustment (DVA) in derivatives pricing accounts for:

Accepted Answer

The bank's own credit risk as viewed from the counterparty's perspective

Answer

The credit risk of the counterparty to the bank

Answer

Changes in the risk-free discount rate over the trade's life

Answer

The expected recovery rate on collateral held by the bank

Question 3

Under Basel III, the Standardized Approach for Counterparty Credit Risk (SA-CCR) replaced the Current Exposure Method primarily because:

Accepted Answer

It better recognizes the risk-reducing effects of netting, collateral, and hedging

Answer

It reduced capital requirements across all asset classes

Answer

It eliminated the need for computing potential future exposure add-ons

Answer

It required financial institutions to use internal models for all derivative exposures

Question 4

What is the primary purpose of an Initial Margin (IM) in bilateral OTC derivatives?

Accepted Answer

To cover potential future exposure from the time of default to the close-out of positions

Answer

To compensate the counterparty for the bid-ask spread on the trade

Answer

To fund the settlement of daily profit and loss between counterparties

Answer

To meet regulatory minimum capital requirements for the bank

Question 5

Variation Margin (VM) in OTC derivatives is exchanged to:

Accepted Answer

Settle the daily mark-to-market changes in portfolio value

Answer

Cover exposure that might arise over the life of the trade

Answer

Compensate for credit spread widening of the counterparty

Answer

Meet initial posting requirements at trade inception

Question 6

In counterparty credit risk, the Margin Period of Risk (MPOR) is defined as:

Accepted Answer

The time from the last margin call to the completion of close-out and re-hedging after a counterparty default

Answer

The duration over which a credit derivative provides protection

Answer

The period during which a collateral agreement is legally contested

Answer

The maximum tenor of a transaction eligible for netting under an ISDA agreement

Question 7

Specific Wrong-Way Risk (SWWR) differs from General Wrong-Way Risk (GWWR) in that SWWR:

Accepted Answer

Arises from a legal or contractual link between the counterparty's default and the exposure value

Answer

Applies only to sovereign counterparties and not corporate entities

Answer

Is driven by macroeconomic correlation between market variables and credit quality

Answer

Requires a Monte Carlo simulation to measure accurately