Credit Risk Management Practice Exam

Which of the following is a primary component of the X-Value Adjustment (xVA)?

1. Market value adjustment (MVA)

2. Funding value adjustment (FVA)

3. Asset-backed adjustment (ABA)

4. Liquidity value adjustment (LVA)

The correct answer is: Funding value adjustment (FVA)

The Funding Value Adjustment (FVA) is a significant component of the X-Value Adjustment (xVA) framework, which encompasses various adjustments to the valuation of derivatives and other financial instruments to account for risks and costs associated with funding. FVA specifically addresses the costs and benefits associated with funding a financial position. It incorporates the differences between the risk-free rate and the actual funding costs incurred by a bank or financial institution when holding an asset or a derivative. This is essential for accurately reflecting the true economic cost of funding, which can vary based on market conditions, the institution's credit status, and the specific characteristics of the financial instruments being traded. In the context of xVA, FVA plays a crucial role in aligning the valuation of derivative positions with the costs associated with maintaining those positions over time, taking into consideration the potential for changes in funding costs due to market fluctuations. This makes FVA an integral part of the comprehensive risk management and valuation approach that xVA represents. Other options like Market Value Adjustment (MVA), Asset-Backed Adjustment (ABA), and Liquidity Value Adjustment (LVA) have distinct purposes but do not encompass the specific focus on funding costs and their implications in the same way that FVA does.