In the post GFC environment, greater focus has been given to the impact of counterparty credit risk. The notion of counterparty credit risk is defined by the risk that a party to a financial contract will fail to fulfil their side of the contractual agreement.
Under IFRS 13, both Credit Value Adjustments (CVA) and Debit Value Adjustments (DVA) need to be calculated dependent on whether the financial instrument is an asset or a liability:
When considering credit risk there are a number of factors that can influence the valuation including:
There are numerous methodologies when considering the calculation of CVA/DVA with the appropriate methodology determined by the size and sophistication of the entity’s holding of derivatives.
How Hedgebook helps:
Hedgebook has a CVA/DVA module to keep the auditor happy. In line with the Hedgebook “demographic” we have deliberately kept the CVA module towards the simpler end of the CVA calculation spectrum. We use the current exposure method which we feel is appropriate for vanilla instruments such as FX forwards, FX options and interest rate swaps for an entity using these instruments for hedging purposes.
The module is broken into the following steps:
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