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6

The name initial margin is somewhat misleading as initial margin is dynamic i.e it is adjusted through time. So, as you say, on day zero, it can be computed as a 10 day VaR VaR(10, t0). But, on day one, the market conditions will have changed, or you may have paid a cashflow etc etc..... so your 10 day VaR will also change (i.e. VaR(10, t1) is not equal to ...


5

"Debt issuer default risk" and "counterparty risk" are very similar. From Risk magazine: Counterparty Risk The risk that a counterparty to a transaction or contract will default (fail to perform) on its obligation under the contract. Counterparty risk is not limited to credit risk (the risk that the counterparty cannot fulfill its ...


4

To continue from uness' answer (edit: just seen the OP was very old, but will leave here anyway!) . The greeks will be every element of market risk to which the the CVA is sensitive. Writing in words for celerity: A CVA is a credit linked option on the underlying instrument. You are sensitive to the credit default- (specifically the swap obligation payment ...


4

CVA is a price. Just like any price, you compute its sensitivities (greeks) and then use financial products to bring them as close to zero as possible. It's not possible to derive a hedging strategy just by looking at the CVA figure, it's like asking what the hedging strategy of a product is if its price is USD 1M... You need the CVA greeks. The ...


4

I don’t think it is exactly correct to say that XVA only apply to derivatives. It is more correct to say they are more relevant to derivatives than cash products such as loans. The reason is that in cash products, the expected exposure is always known. If you have a $\$1m$ loan, your exposure is always $\$1m$ and the credit risk will be incorporated in the ...


4

Assuming zero recovery, let $\mathcal{C}$ be a counterparty you are facing on a derivative deal with value $V(t)$ and maturity $T$ such that $V(t)\geq 0$, for example an option. Let $CDS_\mathcal{C}(t,T)$ be the value at $t$ of a unit-notional CDS on $\mathcal{C}$ with maturity $T$. Then with the portfolio $\pi(t)=V(t)CDS_\mathcal{C}(t,T)$, namely a CDS ...


4

CVA stands for Credit Valuation Adjustment and should be applied to derivatives and not bond portfolios. The reason is that unlike derivatives, a bond has the counterparty credit quality implicitly priced. Consider two bonds with exactly the same features (coupon, maturity, etc) but issued by a different entity. Most likely, the bonds will have different ...


3

You are right, there's not much difference. I think the reason people don't talk about it that way is due to accounting. Derivatives are marked to market (thus requiring an accurate estimate of future credit losses, thus CVA) , whereas loans are typically carried on the books at par value, until they become impaired due to non payment in which case a ...


3

Actually the problem is that the probability of default the second year is conditioned by the default the first year. So you have to multiply 4%*101.21*99%, because 1% of the times it has already defaulted the first year


3

The assets of the SPV constitute a single corporate loan. Therefore the probability of default and LGD of the bond can be estimated from the CDS market for that corporate. Now the SPV defaults if and only if the bond defaults, so you have the probability of the SPV defaulting. Next you need to compute your exposure in a default situation. What matters ...


3

As I see it, the term $\Pi_B(t, T)$ is the value of the derivatives already owned by the bank. So, it's not some price they need to pay but an asset on the balance sheet. This increase in asset value leads to a profit. Balance sheet Example Imagine the balance sheet of OTC Subsidiary with rating A: Assets | Liabilities -----------------...


3

This is an oft-debated topic among CVA/DVA professionals at banks. The key question, as pointed out by one of the comments, is whether a bank can derive some type of benefit from the increase in its own credit spread (and thereby make less of a CVA charge on the proposed transaction). The two sides to the argument are (a) on the one hand, surely by ...


3

A methodology for estimating rating/ region/ sector proxies for ACVA calculations can be found here: http://www.nomura.com/resources/europe/pdfs/cva-cross-section.pdf Please let me know if you need anything to be clarified (caveat: I am one of the authors). The methodology assigns a CDS mark to counterparties that either have no CDS marks, or their marks are ...


3

Your reference says "This method derives implied CDS spreads for unobservable issuers through the interpolation or extrapolation of observable CDS. It is a factor model that constructs CDS spread surface as a function of credit rating and maturity." So this is for issuers which do not have any CDS contracts priced (there are no CDS spreads to bootstrap). I'...


3

There are quite a few methods to calculate default probabilities from CDS data. Simply you start at the shortest tenor, assume constant hazard rate. Then for the next tenor, you assume the previous hazard rate is still valid till the previous tenor, and the hazard rate between the previous tenor and new tenor is calibrated so that CDS PV matches the market ...


3

For a very nice reference on this matter, I recommend Pykhtin and Zhu’s Guide to Modelling Counterparty Credit Exposure, a short paper that thoroughly defines these concepts. Expected Exposure $EE(t)$ (also known as Expected Positive Exposure) for a trade with value $V(t)$ is given by: $$EE(t)=\mathbb{E}[\max(0,V(t))]$$ It is effectively “what you could ...


3

Libor, besides its name, is not a good proxy for uncollateralised funding. In fact, a large bank I worked for had an uncollateralised funding curve which was a a spread of +100bps to Libor. The fact that it was a spread to Libor was for legacy reasons and easier to adopt to existing systems. However, a spread of say +115bps to CSA was equally appropriate. ...


3

The CVA on a cross currency swap comes mostly from the final exchange (being the biggest flow). If you as an end user are paying the EUR, then the bank is receiving the EUR a d paying the USD. They will see that this position is a net receivable, because EUR is more valuable on a forward basis than spot. Receivables attract a higher CVA than payables. (...


2

The presence of a mandatory break in a swap contract should reduce the CVA charge. That's because the CVA calculation models the default probability* swap market value while the swap is alive, so the calculation stops at the break date. There is one caveat: if a bank has a history of "waiving" mandatory breaks (i.e. In practice they never get exercised ) ...


2

This only produces an approximation. As per Gregory (page 256) However, adding a spread to a contract such as a swap, the problem is non-linear since the spread itself will have an impact on the CVA. The correct value should be calculated recursively (since the spread is risky too) until the risky MTM of the contract is zero. He points to a ...


2

The CVA charge in Basel iii reporting increases the capital required for OTC derivatives trading. Apart from CVA, there are DVA and FVA that are important. The adjustments might be unitary reffered to as XVA, as the principle is the same.


2

No need to overcomplexify things. The CVA gives you simply the amount that you expect to lose if and when your counterparty defaults, discounted to today. In your case, you are buying an option. So, you already paid a premium but still expect to receive the payoff at expiry. In a sense, your counterparty owes you the payoff and you can lose this amount in ...


2

If you have a portfolio of derivatives with a counterparty and this counterparty defaults before the trades mature, the net mark to market value of the portfolio will be calculated according to the master agreement and a close-out amount will be supposed to be paid by one party to the other. If this portfolio has a positive mark to market value (from your ...


2

To expand on Quantuple's comments: Default probability The CVA is the price adjustment to take into account the default of the counterpart. So, it is obtained by taking the sum of future expected exposures multiplied by the default probabilities of the counterpart on each period (and by the LGD): $$ CVA = LGD \times \sum_{i=1}^m \frac{DiscountedEE(t_{i-1}) + ...


2

This was originally meant as a comment but was too long to be considered as such. It's all a matter of convention but I would agree with you that there is a sign problem. If you look at it from the perspective of the desk which makes the trade, CVA constitutes a cost (hence a negative amount) which, all other things equal, decreases the overall value of ...


1

The approach is the same in discrete and continuous time. You have $$\text{CVA} = E\left[e^{-\int_0^{\tau} r_u du} \text{EAD}_{\tau} (1-R)\mathbf{1}_{\tau \leq T}\right]$$ where $\tau$ = stochastic time of default ($+\infty$ if the counterparty never defaults) $T$ = deal maturity $\text{EAD}_t$ = exposure at default = exposure (stochastic) to the ...


1

Collateral imperfections: the CVA cover the expected exposure in the event that the counterparty defaults. When the trade is collateralized and subject to variation margin. This exposure will come only from the imperfection of the collateral. Because posting and receiving collateral actually has a cost, usually the collateral agreement will be a threshold ...


1

Unlike VM which covers MtMs , IM covers close-out risk (2 weeks portfolio volatility)., it is dynamic , and required for major OTC users (see BCBS IOSCO 2015 ) i.e top up segregated account if need be so to cover portfolio volatility risk. When the IM profile is available MVA can be calculated, this could be the cost of borrowing cash/securities so to post ...


1

You might want to refer to this blog page. I didn't know the swap method but what is described at this link seems a good approximation. Of course you will need quite a lot of inputs. The problem of the libor that has already fixed is treated too. https://alluve.wordpress.com/2010/04/10/cva-calculation-example/


1

This presentation from Citi might help a bit regarding CVA hedging. If you scroll through you will find some examples which show their hedge structures (sic. suggestions). https://www.boj.or.jp/announcements/release_2010/data/fsc1006a5.pdf Me


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