Credit exposure

[Jaskarn]

Hi @David Harper CFA FRM
Gregory, Chapter 7: Credit Exposure and Funding
In the below table, You have explained the impact of collateral on the exposure amount. E.g Future value is 25 in scenario 1 with no collateral it means we have receivable of 25 from counterparty but if we have posted collateral then our future value reduces to 23 which mean we have still receivable of 23 from counterparty thus in column 4, exposure with collateral should be 23 instead of 2 and netting benefit should be 2 instead of 23.

In scenario 1 how can exposure with collateral be 2? Please help me understand these values.

 

[David Harper CFA FRM]

Hi @Jaskarn

This is Gregory's Table 7.3 (per the label) which I believe merely intends to illustrate the impact of collateral on exposure, where the key formula is (Gregory 11.2) given by a slight modification, adding the C, of the most fundamental relationship: Exposure = max(Value - C, 0). That is, collateral reduces exposure when the value is positive.

I can see that we mislabeled the final column (cc: @Nicole Seaman ), apologies. Rather than "netting benefit" is should simply read "benefit" as this chart is not exploring the benefits of netting but rather the benefits of collateral.

I'm not convinced Gregory's "With collateral" is correct, I think it's possible he meant simply "collateral." That would resolve your issue, because clearly:

• The collateral (net posted by the counterparty) in Scenario 1 is 23, such that "our" exposure when the value = +25, such that exposure reduces to 25 (+value for us) - 23 (net collateral posted by counterparty) = 2 (our exposure when counting collateral).
• In Scenario 2, the collateral (net posted by the counterparty) is 12 such that our exposure when the value = +15 is given by 15 (+value to us) - 12 (collateral net posted by counterparty) = +3 exposure to us
• In Scenario 5, we're out of the money on the position (negative value and our counterparty has credit exposure) such that here we appear to have posted 3 collateral, which is why our exposure is zero without collateral but 3 with collateral.

In this way, the most important arithmetic is [Exposure (no collateral) | if positive] - Collateral = "Benefit", per Exposure = max(Value - C, 0).

But there is to me an option question about the differences between the first two columns; e.g., 25 vs 23, 15 vs 12. It seems to me either Gregory has mislabeled the second column (my first instinct), or the second column intends to show a simulated future value that is influenced by the collateral arrangement, in ways that I could posit theoretically but do not seem to be mentioned explicitly in relevant Chapter 11. I'm not sure and therefore we will write Gregory to see ... thanks,

 

[Jaskarn]

Hi @Jaskarn

This is Gregory's Table 7.3 (per the label) which I believe merely intends to illustrate the impact of collateral on exposure, where the key formula is (Gregory 11.2) given by a slight modification, adding the C, of the most fundamental relationship: Exposure = max(Value - C, 0). That is, collateral reduces exposure when the value is positive.

I can see that we mislabeled the final column (cc: @Nicole Seaman ), apologies. Rather than "netting benefit" is should simply read "benefit" as this chart is not exploring the benefits of netting but rather the benefits of collateral.

I'm not convinced Gregory's "With collateral" is correct, I think it's possible he meant simply "collateral." That would resolve your issue, because clearly:

• The collateral (net posted by the counterparty) in Scenario 1 is 23, such that "our" exposure when the value = +25, such that exposure reduces to 25 (+value for us) - 23 (net collateral posted by counterparty) = 2 (our exposure when counting collateral).
• In Scenario 2, the collateral (net posted by the counterparty) is 12 such that our exposure when the value = +15 is given by 15 (+value to us) - 12 (collateral net posted by counterparty) = +3 exposure to us
• In Scenario 5, we're out of the money on the position (negative value and our counterparty has credit exposure) such that here we appear to have posted 3 collateral, which is why our exposure is zero without collateral but 3 with collateral.

In this way, the most important arithmetic is [Exposure (no collateral) | if positive] - Collateral = "Benefit", per Exposure = max(Value - C, 0).

But there is to me an option question about the differences between the first two columns; e.g., 25 vs 23, 15 vs 12. It seems to me either Gregory has mislabeled the second column (my first instinct), or the second column intends to show a simulated future value that is influenced by the collateral arrangement, in ways that I could posit theoretically but do not seem to be mentioned explicitly in relevant Chapter 11. I'm not sure and therefore we will write Gregory to see ... thanks,

Thanks a lot, @David Harper CFA FRM , This clears my doubt now. Just a general question, While I was going through FRM readings I am feeling that it's vast and mostly theoretical in nature as compared to FRM part 1. Please advise the best way to prepare for the exam as per you. I mean on exam day we are supposed to consolidate all the readings in our mind what is the best way to do as per you?

I am thinking of understanding all the reading once and then redo everything since most are theoretical so that it settles up in my mind.

 

[Nicole Seaman]

Thanks a lot, @David Harper CFA FRM , This clears my doubt now. Just a general question, While I was going through FRM readings I am feeling that it's vast and mostly theoretical in nature as compared to FRM part 1. Please advise the best way to prepare for the exam as per you. I mean on exam day we are supposed to consolidate all the readings in our mind what is the best way to do as per you?

I am thinking of understanding all the reading once and then redo everything since most are theoretical so that it settles up in my mind.

Hello @Jaskarn

It is difficult for us to advise on an individual study plan, as everyone studies and learns differently. We created the following forum thread for this reason, as many members have provided information on their study plans: https://forum.bionicturtle.com/threads/study-plan-guide.8670/. This may help you to create a better study plan based on your individual needs.

Nicole