8008 Exam Dumps | A derivative contract has a negative current replacement value. Which of the following statements is

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PRM Certification - Exam III: Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP - 2015 Edition
PRMIA.8008.v2021-08-28.q125
Question 54

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Question 54/125

A derivative contract has a negative current replacement value. Which of the following statements is true about its loan equivalent value for credit risk calculations over a 2-year horizon?

A. Since the derivatives contract has a negative current replacement value, exposure will be zero.

B. The credit exposure will be a given quintile of the expected distribution of the value of the derivatives contract in the future.

C. The notional value of the derivatives contract should be used for loan equivalence calculations.

D. The current exposure can be used for loan equivalence calculations as that is an unbiased proxy for the future value.

Correct Answer: B

Explanation
The current exposure is negative, so there is no immediate credit exposure. However, since the price of the derivative is volatile, we can reasonably expect the value to be greater than zero sometime in the future. This is a stochastic variable which will have a distribution, and not just a unique value, in the future that will represent the credit exposure. Since there is no unique value, a conservative approach is to pick a quintile of the distribution, and use that as the future value of the derivative contract, with the assurance that the probability of the credit exposure exceeding that quintile is known and has been consciously selected. This number can then be converted to a loan equivalent amount for credit risk purposes. Therefore Choice 'b' is the correct answer. Choice 'a', Choice 'd' and Choice 'c' are incorrect for these reasons.

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