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Which one of the following four statements regarding counterparty credit risk is INCORRECT?
Correct Answer: D
* Counterparty credit risk refers to the risk that the counterparty to a financial contract will default before the final settlement of the contract's cash flows, resulting in a financial loss. This is correctly stated in option A. * The exposure at default (EAD) is indeed variable due to fluctuations in the underlying valuations, such as swaps, as mentioned in option B. * The EAD can be negatively correlated with the probability of default (PD) because as the credit quality of a counterparty deteriorates, their exposure may also decline, correctly stated in option C. * However, dynamic collateral provisions are typically designed to reduce counterparty risk by adjusting collateral requirements based on changes in exposure and credit quality, not to increase it. Therefore, option D is incorrect. References: * How Finance Works: "Counterparty credit risk and its management through collateral provisions is a critical aspect of financial risk management."