Credit Risk Management Counterparty Credit Risk

Question 1

Which measure represents the maximum potential exposure to a counterparty at a specified confidence level over a given time horizon?

Accepted Answer

Potential Future Exposure (PFE)

Answer

Potential Future Exposure (PFE) is the worst-case exposure at a specified confidence level (e.g., 95%) over a defined time horizon, used to set credit limits.

Question 2

Credit Value Adjustment (CVA) is best described as:

Accepted Answer

The market value of counterparty credit risk embedded in a derivatives portfolio

Answer

CVA represents the difference between the risk-free portfolio value and the true portfolio value accounting for the possibility of counterparty default.

Question 3

Under a standard ISDA Master Agreement, netting reduces counterparty credit risk by:

Accepted Answer

Allowing positive and negative mark-to-market values across transactions to offset each other

Answer

Close-out netting under an ISDA agreement allows offsetting of gains and losses across all transactions with a counterparty upon default, reducing gross exposure to a net figure.

Question 4

Wrong-Way Risk (WWR) in counterparty credit risk refers to a situation where:

Accepted Answer

The exposure to a counterparty increases as the counterparty's creditworthiness deteriorates

Answer

Wrong-Way Risk occurs when exposure is adversely correlated with the credit quality of the counterparty — as the counterparty becomes more likely to default, the exposure grows.

Question 5

The Expected Positive Exposure (EPE) metric is primarily used for:

Accepted Answer

Calculating regulatory capital for counterparty credit risk under Basel rules

Answer

EPE — the time-average of expected exposure over a horizon — is used in the IMM approach under Basel III to calculate regulatory capital requirements for CCR.

Credit Risk Management Practice Test

Credit Risk Management Practice Test

Credit Risk Management Counterparty Credit Risk