Adjustments

Abstract

An introduction to interest rates, derivatives and options would not be complete without covering the basics of adjustments. We have already described the major changes in the modern financial markets. We described the observations after August 2007 and outlined the new market practice. One of the issues which was identified as the main drivers for the crisis was counterparty credit risk. In this chapter we take the definition of Credit Exposure given in Chapter 1, Section 1.4 to build our exposition of the different adjustments to consider adjustments with respect to credit risk. We cover CVA in Section 8.2, bilateral CVA (BCVA) and DVA in Section 8.3 and, finally, FVA in Section 8.4. Our examples to illustrate the concept use future scenarios of the yield curve together with a swap contract to illustrate the effects and for providing an example for the calculation.