Credit Risk Management Counterparty Credit Risk 3

Question 1

Which regulatory framework introduced the mandatory clearing and margining requirements for standardized OTC derivatives in the United States?

Accepted Answer

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

Answer

Title VII of the Dodd-Frank Act introduced mandatory central clearing, exchange trading, and margin requirements for standardized OTC derivatives to reduce systemic counterparty credit risk.

Question 2

The Internal Model Method (IMM) for counterparty credit risk allows banks to:

Accepted Answer

Use their own risk models to compute EPE for regulatory capital, subject to supervisory approval

Answer

Under IMM, approved banks use internal Monte Carlo simulations to compute EPE profiles for each netting set, which feed directly into regulatory capital calculations.

Question 3

The 'Alpha' multiplier (typically set at 1.4) in the Basel CCR framework is applied to:

Accepted Answer

The Effective EPE to convert it into a stressed Exposure at Default measure

Answer

The alpha factor of 1.4 (set by regulators) scales the Effective EPE upward to account for model uncertainty and the difference between EPE and full economic exposure at default.

Question 4

A Credit Valuation Adjustment (CVA) desk at a bank primarily manages risk by:

Accepted Answer

Hedging the CVA P&L volatility using CDS, index options, and swaptions

Answer

The CVA desk dynamically hedges the CVA P&L using credit default swaps on individual counterparties, CDS indices, and interest rate or cross-currency hedges to neutralize market and credit sensitivity.

Question 5

Under EMIR (European Market Infrastructure Regulation), which types of OTC derivatives are subject to mandatory central clearing?

Accepted Answer

Standardized OTC derivatives between financial counterparties above a clearing threshold

Answer

EMIR mandates central clearing for standardized OTC derivatives (e.g., plain vanilla interest rate swaps and CDS indices) when counterparties exceed specified clearing thresholds.

Credit Risk Management Practice Test

Credit Risk Management Practice Test

Credit Risk Management Counterparty Credit Risk 3