By Dongsheng Lu
This most up-to-date addition to the monetary Engineering defined sequence makes a speciality of the hot criteria for derivatives valuation, particularly, pricing and danger administration making an allowance for counterparty hazard, and the XVA's credits, investment and Debt worth adjustments.
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Additional resources for The XVA of Financial Derivatives: CVA, DVA and FVA Explained
At the occurrence of the reference credit event, the CDS seller will fulﬁll the obligation to provide the credit protection. For example, if the reference entity is a bond, the CDS buyer may deliver the bond to the CDS seller and the CDS seller will pay the par value of the bond. The size of CDS spread is one of the cleanest indicators for credit entity default probabilities as viewed by the market.
With the reduction of credit risk, the trading counterparties are able to do more business with each other within a deﬁned credit risk limit. The type of collateral is speciﬁcally deﬁned in the CSA, including the collateral currencies, collateral assets and haircuts. The CSA also deﬁnes whether the collateral can be rehypothecated or not. Rehypothecation is the market practice whereby a counterparty can reuse the security pledged as collateral for its own use. Rehypothecation allows the lender to use the pledged collateral in its own funding activities, such as deploying in the repo market, or pledging to others for its own trades and borrowings.
For example: • Trade Speciﬁc Break Clause For the purpose of reducing credit risk, mutual put breaks are sometimes included in conﬁrmations, which can be exercised for a speciﬁed frequency. These mutual options are discretionary and can be exercised by either party. Mutual put breaks are clearly important credit mitigants for both trading parties, and are important components in CVA and Risk Weighted Asset (RWA) calculations. As the banks become more and more sensitive to the capital related requirements, mutual put exercises have become increasingly popular over the past a few years.
The XVA of Financial Derivatives: CVA, DVA and FVA Explained by Dongsheng Lu