Handbook of Credit Risk Management, Ch 5: Dynamic Credit Exposure

Question 1

State the two common methodologies to assign credit exposure to instruments with
dynamic credit exposure

Answer 1

1. Mark-to-market (MTM)
2. Value-at-risk (VaR)

Question 2

State the major parameters that influence MTM value of a contract and thus the credit
risk it generates.

Answer 2

1. Predetermined conditions of the contract (e.g. $3 per gallon)
2. Time left on the contract
3. Prevailing market conditions at the time the MTM computation is performed

Question 3

Compare Positive vs Negative MTM

Answer 3

Positive vs Negative MTM

MTM can be positive or negative:
Ÿ Positive MTM means the counterparty owes you and you are subject to credit risk
Ÿ Negative MTM means you owe the counterparty (thus, no credit exposure)

From a credit risk management perspective, only positive MTM are relevant

Question 4

Describe marking to market (MTM).

Answer 4

Marking to market (MTM) a contract means calculating its replacement cost, taking
into account the prevailing value of the underlying product