Module: | MODULE B: RISK MANAGEMENT
Q288: Scenario: An active commercial bank holds significant positions in government bonds and foreign currency swaps, all properly classified within its proprietary trading desk. Based on Basel and RBI regulations, consider the following statements regarding the capital charge allocation for these exposures:
1. The bank must calculate a capital charge for general market risk, to cover potential losses from macroeconomic interest rate shocks on its bonds.
2. For the foreign currency swaps, the bank must apply a specific market risk capital charge, to account for counterparty credit default risk.
3. The government bonds held for trading, are subject to daily mark-to-market valuations, which immediately impact the bank's daily earnings.
Which of the statements given above is/are correct?
2. For the foreign currency swaps, the bank must apply a specific market risk capital charge, to account for counterparty credit default risk.
3. The government bonds held for trading, are subject to daily mark-to-market valuations, which immediately impact the bank's daily earnings.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is correct: All debt securities (like government bonds) held in the trading book are subject to a General Market Risk capital charge to protect the bank against broad interest rate movements.
Statement 2 is incorrect: This is a deliberate conceptual trap.
Foreign currency swaps do carry market risk (foreign exchange risk), but the risk of the counterparty defaulting is explicitly covered under Counterparty Credit Risk (CCR). Specific Market Risk applies to the issuer of a debt/equity security, not to the counterparty in an OTC derivative contract.
Statement 3 is correct: The defining characteristic of trading book assets, including government bonds, is that they are subject to strict daily Mark-to-Market (MTM) accounting, with valuation changes hitting the daily P&L directly.
Statement 2 is incorrect: This is a deliberate conceptual trap.
Foreign currency swaps do carry market risk (foreign exchange risk), but the risk of the counterparty defaulting is explicitly covered under Counterparty Credit Risk (CCR). Specific Market Risk applies to the issuer of a debt/equity security, not to the counterparty in an OTC derivative contract.
Statement 3 is correct: The defining characteristic of trading book assets, including government bonds, is that they are subject to strict daily Mark-to-Market (MTM) accounting, with valuation changes hitting the daily P&L directly.