compare the two questions: 09 exam Q9, the credit risk is the difference of currency you potentially receive CURRENTLY, as you hold the asset, you won’t loss holding all the money, hence it is the difference. There is NO discount (e.g. 1+ RFR) in denominator in any circumstances (European or American) 10 Mock Q17, you dont hold anything in hand, only the call with strike of 30, you are losing the holding of 35, hence 35 is the total amount of credit risk EOC, current 96, premium 6 and option price 101, the credit risk is 6, as it is the IMPLIED value? (re: http://www.analystforum.com/phorums/read.php?13,1155620,1155908#msg-1155908) but it doesn’t really make sense to me. Anyone totally on top of this?
bump, please
any explanation please?
there is only the potential loss with a european option. The premium is already gone. There is no current credit risk until the option expiration date. for your second question, if you are holding a call with strike of 30 and the stock price is currently 35 (sorry, I don’t have the actual question handy) then if the counterparty fails to deliver the stock, yes, you would lose $35 so that’s the credit exposure. for your third question, it seems that if the strike is 101 and stock price is only 96, the option is out of the money. there would be no credit risk on either side. Yes, the buyer is out the premium paid, but this isn’t credit risk. Does this help?
it is indeed very confusing the way CFAI talk about this. I am also unclear - in reality (in the market) 'current’credit risk is measured as the amount it will cost you to replace the trade if the counterparty defaults today (i.e. the current value of the option). Potential credit risk is how much you could lose in the future (i.e. how much could the price of the option move in your favour - and then the counterparty might default therefore you lose more than you would today). It’s very frustrating when a credit risk analyst disagrees with CFAI version of credit risk!
Not sure how I can improve upon that thread. I can put it in a bit of a different light. Think in accounting terms: Current credit risk = current receivable Potential credit risk = MV of future receivable If you have a payable, you have zero credit risk. Your counterparty has credit risk. So current & potential risk for an option writer is always zero (he never has a receivable, only a payable). Likewise, if it is out of the money, there is no credit risk for either, since no one has a current receivable. On the mock, the bank has a receivable that is currently worth 35. If the payor does not pay, he has lost 35. The only reason they are dividing by he rf is because they need to get a present value. That is the best approximation of the current mkt value. That help?
thanks guys, I am still unclear … MMGWK, I never saw a question for option credit risk that divided by Rfr, although i always feel it should be. but if they give me in the exam, I may just use it. the 3rd item still remain open though, which I may just have to ignore as haven’t seen such a thing in any mock or exam by myself. or anyone can add to this discussion?