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date.47 In order to translate this plethora of numbers
characterizing the exposure into a single number, FNBC selected
and applied an 80-percent confidence level during the relevant
years to ascertain a maximum credit exposure through time for
this confidence level.48 The CEM amount was useful for risk
management purposes in that it alerted management when a
portfolio’s potential exposure was increasing, it identified the
portions of the portfolio with the greatest exposure, and it
allowed management to identify the most potentially dangerous
swaps for special attention. The CEM amount was not an accurate
price of credit risk and was inappropriate for pricing or
valuation.
FNBC’s VEP system overstated FNBC’s credit exposure in that
the system did not consider collateral and other security or the
offsetting losses with the same counterparties based on legally
enforceable termination and netting rights. FNBC reported this
deficiency in its 1993 annual report. That report acknowledged
that credit exposure amounts might be overstated since those
amounts did not take into account collateral, other security, or
termination and netting rights.
47 The important characteristics of the distribution of
possible outcomes of some swaps could be calculated directly and
did not require a Monte Carlo simulation.
48 Initially, FNBC calculated the CEM amounts at a
95-percent confidence level but reduced that level to 80 percent
in 1989.
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