Lecture_7_CVA_201820180402201111

Introduction
Counterparty Risk
Counterparty Risk vs Credit Risk
Unlike a firm’s exposure to credit risk through a loan, where the exposure to
credit risk is unilateral and only the lending bank faces the risk of loss, the
counterparty credit risk creates a bilateral risk of loss: the market value of the
transaction can be positive or negative to either counterparty to the transaction.
[Basel II, Annex 4, 2/A]
Loans:exposure at any future date is the outstandingbalance, which is certain
(without considering prepayments). Credit risk is unilateral
Derivatives: exposure at any future date is determined by the market value
at that date and is uncertain. Counterparty risk can be:
unilateral: one party (the investor) is considered default-free and only the exposure
to the counterparty matters
bilateral: both parties are considered risky and face exposures depending on the
value of the positions they hold against each other
Paola Mosconi 20541 – Lecture 10-11 6 / 86