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Aldiman15
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Joined: January 21st, 2011, 3:17 am

CVA Charge

January 22nd, 2011, 3:28 pm

Can anyone explain how the CVA charge is actually calculated on say a 5 year interest rate swap? Is the CVA only charged on trade entry?
 
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RedAlert
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Joined: April 11th, 2002, 10:54 am

CVA Charge

July 3rd, 2011, 9:33 pm

No CVA needs to be recalculated throughout the life of the trade.Essentially CVA is complicated because it is not considered in isolation for one trade. What a firm will usually do is consider it's entie exposure to a particular counterparty and calculate a CVA charge on that basis. So if we consider your classical Interest Rate Swap, the game is to look at the risk factors of the instrument in question, in this case it is simply interest rates (and if you are being fancy correlate this to the hazard rate of the counterparty). Next simulate future states of the world for each risk factor and calculate the expected positive exposure. You then discretise time and work out the expected loss in each interval by taking the EPE for the interval and multiplying by the default probability (often using market implied CDS - but not always!) and include a Recovery Rate assumption.Often firms will include so called DVA (Debt Value Adjustment) also referred to as Bilateral CVA which is the symmetric number using the Expected Negative Exposure and the Probability of default of the own firm.Hope this terse summary is of some help. To be frank you are best off googling this as there are millions of articles on the topic.RegardsFred
 
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bonosmate
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Joined: February 28th, 2008, 9:28 am

CVA Charge

July 5th, 2011, 10:13 am

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. As Redalert points out there's loads on the net on this topic so google it