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Home > Resources > WIKI

Credit Exposure to a Counterparty

Credit exposure to a counterparty for a financial instrument is a measure of the amount lost if the counterparty defaults. The current exposure is simply the positive part of the instrument's market value, and the future exposure is the positive part of the market value at a future time. The future exposures are used to calculate several exposure metrics, including a counterparty's credit value adjustment.

There are two types of future exposures: worst exposures, and expected exposures. A worst exposure at a given time is the largest possible loss of the instrument at a certain confidence level when the counterparty defaults. An expected exposure is a measure of the expected loss of the instrument at a given time.

A maximum exposure is the maximum future exposure over many future time points. The sequence of credit exposures at selected time points which are used to calculate a maximum credit exposure is called the credit exposure profile.

To estimate a future exposure, we need to model the distribution of risk factors of the instrument and evaluate the instrument based on these risk factors. Different models will lead to different credit exposure values.

FINCAD provides the ability to calculate several credit exposure metrics, including a counterparty's credit value adjustment. These exposure metrics are calculated for a portfolio of interest rate securities, which can include swaps (amortizing and non-amortizing), bonds (amortizing and non-amortizing), and arbitrary fixed cash flows. The interest rate evolution is based on either the Hull-White or Black-Karasinski short-rate model.

FINCAD also provides an alternative method for calculating one-day, maximum, and future worst exposures for forward-starting interest rate swaps and forward rate agreements (FRAs). This alternative method is based on the Black model and assumes that forward rates and swap rates are lognormally distributed. In both cases, using either a short-rate model or the Black model, a single risk factor drives the level of the yield curve.

To find out more information about FINCAD products and services, contact a FINCAD Representative.