PRMIA Exam 8010 Topic 1 Question 16 Discussion

The correct definition of CVA is LGD * EPE * PD. All other answers are incorrect.

CVA reflects the adjustment for counterparty default on derivative and other trading book transactions. This reflects the credit charge, that neeeds to be reduced from the expected value of the transaction to determine its true value. It is calculated as a product of the loss given default, the probability of default and the average weighted exposure of future EPEs across the time horizon for the transaction.

The future exposures need to be discounted to the present, and occasionally the equations for CVA will state that explicitly. Similarly, in some more advanced dynamic models the correlation between EPE and PD is also accounted for. The conceptual ideal though remains the same: CVA=LGD*EPE*PD.