[ 2009 FRM Sample Exam ] Quantitative Analysis Q3 customers, following, interest, between, company

lalamei

 

3. Counterparty A is an American company with manufacturing operations in Indonesia and its main customers in the US, while Counterparty B is an American company that manufactures its goods domestically and exports solely to Indonesia. Which one of the following transactions with either counterparty will be a wrong-way exposure for a bank?

A. A 5-year plain vanilla IDR/USD cross-currency swap between the bank and Counterparty A where the bank is USD interest rate receiver.

B. A 5-year plain vanilla IDR/USD currency option sold by the bank to Counterparty A for it to buy IDR at a certain rate.

C. A 5-year plain vanilla IDR/USD cross-currency swap between the bank and Counterparty B where the bank is USD interest rate receiver.

D. A 5-year plain vanilla IDR/USD currency option bought by the bank from Counterparty B for the bank to buy IDR at a certain rate.

lalamei

 

Correct answer is C

A is incorrect. When the IDR depreciates sharply, the Mark-to-market (MTM) of the swap will be positive for the bank. At the same time, the Counterparty's business will likely to benefit from it as its manufacturing costs will be lower. Hence, the exposure is not wrong-way in nature as the credit quality of Counterparty A is not negatively correlated to the MTM of the swap.

B is incorrect. Vanilla options (where premiums are paid upfront) sold by the bank has not credit exposure.

C is correct. When the IDR depreciates sharply, the Mark-to-market (MTM) of the swap will be positive for the bank. At the same time, the Counterparty's business will likely to suffer from it as its exports to Indonesia will be more expensive to its Indonesia customers. Hence, the exposure is wrong-way in nature as the credit quality of Counterparty A is negatively correlated to the MTM of the swap.

D is incorrect. When the IDR depreciates sharply, the Counterparty's business will likely to suffer from it as its exports to Indonesia will be more expensive. However, the MTM of the option will be negative for the bank. Hence, the exposure is not wrong-way in nature as the credit quality of Counterparty B is not negatively correlated to the MTM of the swap.