-235-
method of calculating the credit adjustment inappropriately
accelerates to inception the maximum amount of credit risk
presented during the life of the swap. As for the recommendation
of the G-30 report, which of course was not made for purposes of
valuing swaps for Federal income tax purposes, but for risk
management purposes, the G-30 report specifically endorsed a
dynamic procedure. Not only was a static procedure not
recommended by the G-30 report, but such a procedure was not
followed as a matter of industry practice.
8. Confidence Levels
Petitioner argues that FNBC’s use of an 80-percent
confidence interval was reasonable and consistent with industry
practice. Respondent argues that FNBC’s use of the 80-percent
confidence level was improper. We agree with respondent.
When credit exposure is overstated, the credit adjustment
does not reflect the market value of credit risk and cannot
accurately reduce midmarket values and arrive at fair market
value. FNBC was the only known entity in the industry that used
an 80-percent confidence level when computing credit exposure,
and its use of a maximum 80-percent measure of exposure
overstated credit exposure. In fact, all of the experts on
financial derivatives opined that the CEM amount should use a
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