Abstract
Contingent credit exposure is most commonly associated with bilaterally negotiated financial derivatives transactions, such as interest rate swaps, forward rate agreements, purchased options, equity and commodity derivatives, over-the-counter foreign exchange transactions, and credit derivatives. Banks design various systems and controls to prevent sales and trading personnel from booking swaps unless sufficient availability exists within the relevant approved credit facility. It is important to note that passive exceptions may not be uncommon. Estimating total exposure as the sum of a contract's mark-to-market value plus its potential future exposure is a common and convenient way to measure contingent credit exposure. However, this approach has limitations. For users of this approach, it may be appropriate to incorporate additional procedures and controls to address these limitations in accordance with the bank's objectives and portfolio characteristics. More accurate approaches involve numerically intensive direct simulation of the potential future contract values, but those approaches are beyond the scope of this article.