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An event of default by a
counterparty prior to the stated maturity date of an OTC derivative
contract will trigger its early termination and the settlement of
a close-out amount between the counterparties. The close-out amount
is defined as the replacement cost of the OTC derivative contract
determined by either market quotation or loss. Where it is legally enforceable to net the close-out amounts across a portfolio of OTC derivative contracts pursuant to an event of default by a counterparty, the portfolio of OTC derivative contracts constitutes a netting set. Where close-out netting is not legally enforceable, each OTC derivative is viewed as a separate netting set. A counterparty can default on any date up to and including the stated maturity date of the contract. While the replacement cost of a netting set is known today, its replacement cost in the future is uncertain. To address this uncertainty, the potential replacement cost of the netting set is simulated throughout its remaining life against a population of potential market scenarios. From this population of simulated replacement costs, counterparty credit risk managers construct: • An expected positive exposure profile: the average positive simulated replacement cost at each future time interval. • A maximum positive exposure profile: the maximum positive simulated replacement cost at each future time interval. CCR is defined as the current or potential positive replacement cost of an OTC derivative netting set at a specified point in time. |
© 2008 Novarum Partners Limited