-83-
3. Use of Dealer’s Own Costs
Dealers calculated their administrative costs adjustments on
the basis of their own internal estimates of future costs. There
was neither a market standard for administrative expenses related
to swaps, nor a market standard (or market data) for an
administrative costs adjustment whether on a swap-by-swap or
portfolio basis.
Dealers did not know the level of administrative (or other)
costs experienced by other dealers. That information was
generally regarded as proprietary and was not public.
C. Adjustment for Counterparty Credit Risk
1. Overview
A party to a swap was exposed to credit risk. The party’s
credit risk was the potential change in the market price of the
party’s position in the swap due to the credit quality of the
counterparty. The event of a default by the counterparty lowered
the market price of that position, and the danger of default was
the ultimate source of credit risk. Short of an actual default,
a downgrade in the counterparty’s credit rating could also affect
the market price of the party’s position in the swap. Credit
risk included the danger that the market price of the party’s
position in a swap would fall because of a downgrade in the
credit rating of the counterparty.
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