Credit Valuation Adjustment and Counterparty Credit Risk Workbook
Any firm participating in the OTC derivatives market is exposed to counterparty credit risk, which is the risk that a counterparty will default and fail to make the future payments that were agreed to in the derivative contracts. Modeling credit exposure is a vital part of the risk management of positions in OTC derivatives.
A common measure of counterparty credit exposure is the Maximum Peak Exposure. This is the maximum amount of loss that would occur if the counterparty were to default at any point in the future, for a given statistical confidence level. In other words, what is the greatest future exposure over all future paths of the relevant risk factors between now and the maturity of the derivative contracts.
The counterparty credit risk should also be taken into account when reporting the fair value of any derivative position - the adjustment to the value is known as the Credit Value Adjustment (or Credit Valuation Adjustment). For years, a widespread practice in the industry has been to mark derivatives portfolios to market without taking the counterparty risk into account. All cash flows were discounted using the LIBOR or risk-free curve. However, the true portfolio value must incorporate the possibility of losses due to counterparty default. This observation has gained wider recognition following the high-profile defaults of 2008. The Credit Value Adjustment is by definition the difference between the risk-free portfolio and the true portfolio value that takes into account the possibility if a counterparty's default. In other words, CVA represents the monetized value of the counterparty credit risk.
FINCAD Analytics Suite for Excel provides the analytics and the functionality to calculate all these quantities for a portfolio of fixed-floating interest-rate swaps. View the demo to the right featuring the Amortizing Swap Portfolio workbook. Despite the name, this workbook is also easy to use for a portfolio of non-amortizing, or vanilla swaps.
For more sophisticated portfolios or if you're looking for different approach to CVA, you can view the demo to the right showing F3's Flexible CVA Solution.
You can find out more about FINCAD solutions for CVA by requesting a customized demonstration.