Credit Risk Management Practice Exam

What defines the concept of incremental CVA?

1. It is used to assess the effect of an existing trade

2. It calculates the total exposure across all trades

3. It determines the cost of a new trade versus an existing one

4. It analyzes margin requirements for trading

The correct answer is: It determines the cost of a new trade versus an existing one

The concept of incremental CVA, or Credit Valuation Adjustment, specifically focuses on evaluating the risk and potential costs associated with a new trade in relation to existing trades. This measure is crucial for a financial institution or an investment firm to understand how a new transaction will affect overall credit risk exposure and pricing. When considering a new trade, incremental CVA quantifies the additional credit risk that the trade introduces, allowing risk managers to make informed decisions about whether to proceed with the transaction. This approach is essential in credit risk management because it directly impacts the overall profitability and safety of a firm's trading portfolio. It helps to ascertain if the potential rewards of the new trade justify the added credit risk, ensuring that firms maintain a balanced approach to risk-taking. In contrast, assessing the effect of an existing trade does not capture the additional risk posed by new transactions. Calculating total exposure across all trades provides valuable insights but lacks the focus on individual trade contributions to credit risk. Analyzing margin requirements focuses on liquidity needs rather than the credit risk implications of new trades. Thus, identifying the incremental CVA helps integrate new trades into the broader context of credit risk management strategies effectively.