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Function documentationCredit and Debit Value Adjustments

 

You can include credit und debit value adjustments in the calculation of the NPVs for single transactions and netting groups.

  • A credit value adjustment (CVA) is the amount by which the risk-free NPV of a financial transaction is adjusted to reflect the probability of a default by a business partner. CVA is a positive amount. It is deducted from the risk-free NPV.

  • A debit value adjustment (DVA) is the amount by which the NPV of a financial transaction is adjusted to reflect the probability of a default by your own company. The absolute value of a DVA must be added to the risk-free NPV. As the DVA is defined as a negative amount, this means that the DVA needs to be subtracted from the risk-free NPV.

The NPV of a financial transaction with the inclusion of CVA and DVA is obtained as follows:

NPV = risk-free NPV - CVA - DVA

If a financial transaction has collateral, the collateral has a risk-mitigating effect. The expected exposures are reduced, thereby leading to a reduction of the CVA/DVA values.

The results of the calculations (NPV, risk-free NPV, CVA, and DVA) are stored at the level of the financial transactions in the NPV table (table VTVBAR). You can consequently access them here for use in key date valuation.

Note Note

This function is available for the following contract types:

  • 4 Foreign Exchange

  • 5 Money Market

  • 6 Derivatives

End of the note.

Prerequisites

Features

Calculation of Credit and Debit Value Adjustments

You use the function Determine NPVs Including CVA and DVA (transaction TPM60CVA) to include CVA and DVA values in NPV calculation.

In this function, you can specify a currency.

  • If you specify a currency, all values for single transactions and netting groups are calculated in this currency, and the intermediate results and final results are stored in this currency.

  • If you do not specify a currency, the calculation is made for single transactions in the position currency and for netting groups in the netting group currency. When the results are saved in the NPV table, the final results are translated into the position currencies of the relevant transactions, including the final results for transactions that form part of the netting group. The system calculates only the intermediate results (EE, CVA/DVA) in the netting group currency.

The final results at the level of the financial transactions are stored in the NPV table (table VTVBAR, transaction JBNPV). You can also display the calculation logs as well as the intermediate results (such as the results for the netting groups) in the NPV table by choosing the CVA/DVA Key Figures pushbutton. The calculation logs are also displayed in the results list after you have performed the function.

CVA and DVA can be calculated in the system in the following ways:

  • CVA/DVA Calculation Method 1: Difference Method

    With this method, the system first calculates the (risk-based) NPV using the yield curve stored in the evaluation type. If you have also made the settings for credit spreads, the system also takes credit spreads into account when calculating the NPV (in a composite yield curve).

    In this way, the system calculates the risk-free NPV with the risk-free yield curve stored in the evaluation type.

    The CVA or DVA is the difference between the risk-free NPV and the (risk-based) NPV:

    Risk-free NPV - NPV = CVA or DVA

    Caution Caution

    This method is available for single transactions only.

    End of the caution.

  • CVA/DVA Calculation Method 2: Based on Expected Exposures

    With this method, the system calculates the risk-free NPV on the basis of the risk-free yield curve that is assigned in the relevant evaluation type. The system calculates the CVA/DVA separately. First of all, the expected exposures for a set of future dates are calculated (or entered manually), aggregated, and weighted with the product of default probability (AWKT) and loss given default (LGD).

    Note Note

    This method can be used for single transactions and netting groups.

    End of the note.

    CVA and DVA values are calculated using the following equations:

    where

    • LGD = loss given default

    • D = discount factor

    • t = time

    • EPE = expected positive exposure

    • ENE= expected negative exposure

    • AWKT = default probability

    • C in subscript = business partner/counterparty of the transaction

    • I in subscript = your own company

    • EPE and CVA are positive

    • ENE and DVA are negative

    The calculation requires the credit spread curve for the reference entity of either the counterparty or your own company in order to obtain the product AWKT*LGD as follows:

    LGD*AWKT (ti-1, ti) = CS (ti)*(ti - t0) - CS (ti-1)*(ti-1 - t0)

    See also: Deriving Credit Spread Curves

    The NPV is calculated as follows:

    Risk-free NPV - CVA - DVA = NPV

Expected Exposures

You use the expected exposure type to specify the method with which the expected exposures are calculated. You can choose from the following three options:

  • Constant Exposure Approach

    The NPV of the financial transaction is calculated for the evaluation date, based on the assumption that the NPV remains constant until the end of the term. A plus sign denotes a constant expected positive exposure (EPE), and a minus sign denotes a constant expected negative exposure (ENE).

  • Variable Exposure Approach

    For each EE date (maturity band date), the NPV is calculated for the evaluation date using the EE date as the horizon. Depending on whether the value determined has a plus or minus sign, it is either an ENE or an EPE.

Note Note

In the case of netting groups, the NPVs of the single transactions are first added together; subsequently, the decision regarding whether ENE or EPE applies for the EE date is made for that netting group.

End of the note.

  • Manual Entry

    The system does not calculate the values of the expected exposures; instead, you enter the values manually using the function Enter Expected Exposures (transaction TPMEEM).

You use the function Enter Expected Exposures (transaction TPMEEM) to enter exposures that need to be entered manually. Further, you can use the function to display expected exposures that already exist in the system. You cannot change expected exposures determined by the system.

Allocation

After you have calculated the CVA and DVA as well as the NPVs for a netting group, the system still needs to distribute the CVA and DVA values to the single transactions of the netting group. For this, the system uses the allocation method that you have selected in the CVA/DVA type.

  • Gross Relative Fair Value Approach

    CVA and DVA are distributed across all transactions of the netting group in proportion to the NPV (fair value) of the transactions.

  • Net Relative Fair Value Approach

    The system proportionally distributes CVA across the transactions with a positive NPV (fair value), and DVA across those with a negative NPV (fair value).

The final results at the level of the financial transactions are stored in the NPV table (table VTVBAR, transaction JBNPV). You can also display the calculation logs as well as the intermediate results (such as the results for the netting groups) in the NPV table by choosing the CVA/DVA Key Figures pushbutton. The calculation logs are also displayed in the results list after you have performed the function.

See also: Maintain NPVs (transaction JBNPV)

Archiving

The entries in the NPV table (table VTVBAR), the logs (table TRPT_LOG), and the calculation results (tables FTBCVAD_CVA and FTBBCVA_EE) are archived using archiving object TRTM_TPM TRM-TM: Positions.

See also: Archiving Positions with TRTM_TPM