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