-87-
transactions. An interval of two standard deviations corresponds
to a 95-percent confidence level.
C. Expected Exposure
Expected exposure is the mean exposure which is used for
valuing credit risk.
iii. OCC’s Position
BC-277 stated that for risk management purposes every bank
should have a system to quantify “current exposure (‘mark-to-
market’) as well as potential credit risk due to possible future
changes in applicable market rates or prices (‘add-on’).” BC-277
stated further that “This methodology should produce a number
representing a reasonable approximation of loan equivalency, that
is, the amount of credit exposure inherent in a comparable
extension of credit.”
iv. Methods Used To Calculate
Complex models were used to measure credit exposure for
interest rate swaps. Initially, some swaps dealers measured
potential exposure using a scenario approach. They would analyze
a limited number of future interest rate scenarios and track the
value of the swap over time to determine the maximum amount at
risk if the counterparty were to default. Under this approach,
the worst case scenario was regarded as the potential exposure.
This approach had many deficiencies, and, by the 1990s, most
dealers were trying to develop more sophisticated tools.
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