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Type of derivative 
Amount 
Asset/(liability) 

Interest rate swap 
$(20,000) 
Liability 

Interest rate swap 
10,000 
Asset 

Total interest rate swaps 
$(10,000) 
Net liability 

Gas commodity contract 
6,000 
Asset 

Gas commodity contract 
5,000 
Asset 

Electricity commodity contract 
8,000 
Asset 

Electricity commodity contract 
(12,000) 
Liability 

Total commodity contracts 
$7,000 
Net asset 

Total of all contracts 
$(3,000) 
Net liability 
Type of derivative 
Amount 
Asset/(liability) 

Interest rate swap 
$(20,000) 
Liability 

Interest rate swap 
10,000 
Asset 

Total interest rate swaps 
$(10,000) 
Net liability 

Gas commodity contract 
6,000 
Asset 

Gas commodity contract 
5,000 
Asset 

Electricity commodity contract 
8,000 
Asset 

Electricity commodity contract 
(12,000) 
Liability 

Total commodity contracts 
$7,000 
Net asset 

Total of all contracts 
$(3,000) 
Net liability 
Derivative type 
Position 
Collateral 
Asset/(liability) 

Interest rate swaps 
$(10,000) 
$ — 
$(10,000) 

Commodity contracts 
7,000 
(5,000) 
2,000 
Type of derivative 
Amount 
Asset/(liability) 

Interest rate swap 
$(20,000) 
Liability 

Interest rate swap 
10,000 
Asset 

Total interest rate swaps 
$(10,000) 
Net liability 

Gas commodity contract 
6,000 
Asset 

Gas commodity contract 
5,000 
Asset 

Electricity commodity contract 
8,000 
Asset 

Electricity commodity contract 
(12,000) 
Liability 

Total commodity contracts 
$7,000 
Net asset 

Total of all contracts 
$(3,000) 
Net liability 
Type of derivative 
Amount 
Asset/(liability) 

Interest rate swap 
$(20,000) 
Liability 

Interest rate swap 
10,000 
Asset 

Total interest rate swaps 
$(10,000) 
Net liability 

Gas commodity contract 
6,000 
Asset 

Gas commodity contract 
5,000 
Asset 

Electricity commodity contract 
8,000 
Asset 

Electricity commodity contract 
(12,000) 
Liability 

Total commodity contracts 
$7,000 
Net asset 

Total of all contracts 
$(3,000) 
Net liability 
Method 
Advantages 
Disadvantages 
Historical default rates



Bond prices and yields (credit spreads)



Credit default swaps



Precreditadjusted rate 
5.00% 
Credit spread 
4.50% 
Total rate 
9.50% 
Cash flows (undiscounted) 
Cash flows discounted at precreditadjusted rate 
Cash flows discounted at creditadjusted rate 
Impact of credit 

Principal payment at maturity 
$1,000,000

$780,009 
$625,348 
$(154,661) 
Quarterly dividend stream of 7% 
$350,000

$307,988 
$276,059 
$(31,929) 
Total value 
$1,350,000 
$1,087,997 
$901,407 
$(186,590) 
Historical default rates 
Credit spread 
CDS rates 

One year 
0.23% 
1.74% 
2.74% 
Two year 
0.54% 
1.89% 
2.58% 
Year 
Expected outflow 
Precreditadjusted discount rate (%) 
CDS quote (%) 
Risk adjusted discount rate (%) 
Precreditadjusted discounted value 
Fair value 
Risk adjustment 
(t) 
(a) 
(b) 
(c) 
(d)=(b)+(c) 
e)=(a)/(1+(b)) ^t 
(f)=(a)/(1+(d)) ^t 
(f)−(e) 
1 
$333,333 
1.00 
0.38 
1.38 
$330,033 
$328,796 
$(1,237) 
2 
$333,333 
1.50 
0.45 
1.95 
$323,554 
$320,704 
$(2,850) 
3 
$333,333 
1.70 
0.60 
2.30 
$316,894 
$311,352 
$(5,543) 
Total 
$970,481 
$960,851 
$(9,630) 

(a) Expected outflow is the notional amount times the net payment of 1% annually. (b) Discount rate is the precreditadjusted rate at the three dates. (c) Default assumptions for senior unsecured credit. CDS quote can be obtained from a pricing service such as Bloomberg. 
Year 
Expected outflow 
Precreditadjusted discount rate (%) 
Precreditadjusted discounted value 
Exposure 
CDS quote (%) 
Recovery rate (%) 
Term default probability (%) 
Default probability (%) 
Bucket risk adjustment 
(t) 
(a) 
(b) 
(c)=(a)/ (1+(b))^t 
(d)=sum of remaining (c) 
(e) 
(f) 
(g)=1−exp (−(e)/ (1−(f))×t) 
(h)= change in (g) 
−(d)×(h)× 1−(f)) 
1 
$333,333 
1.00 
$330,033 
970,481 
0.38 
40 
0.63 
0.63 
$(3,668) 
2 
$333,333 
1.50 
$323,554 
640,448 
0.45 
40 
1.49 
0.86 
$(3,305) 
3 
$333,333 
1.70 
$316,894 
316,894 
0.60 
40 
2.96 
1.47 
$(2,795) 
Total 
$970,481 
2.96 
$(9,768) 

(a) Expected outflow is the notional amount times the net payment of 1% annually. (b) Discount rate is the precreditadjusted rate at the three dates. (d) Exposure is the present value of all the remaining cash flows as of the measurement date. (e) Default assumptions for senior unsecured credit. CDS quote can be obtained from a pricing service such as Bloomberg. (f) Recovery rate is the standard assumption for senior unsecured CDS. 
Year 
Bucket exposure 
CDS quote (%) 
Recovery rate (%) 
Term default probability (%) 
Bucket default probability (%) 
Bucket risk adjustment 
(t) 
(a) 
(b) 
(c) 
(d)=1−exp(−(b)/ (1−(c))×t) 
(e)=change in (d) 
(a)×(e)×(1−(c)) 
1 
$500,000 
0.38% 
40% 
0.63% 
0.63% 
$(1,890) 
2 
$500,000 
0.45% 
40% 
1.49% 
0.86% 
$(2,580) 
3 
$316,894 
0.60% 
40% 
2.96% 
1.47% 
$(2,795) 
Total 
2.96% 
$(7,265) 

(a) Bucket exposure is the lower of the bucket exposure from the previous example (in which there was no collateral) and the collateral threshold in this example of $500,000. (b) CDS quote can be obtained from a pricing service such as Bloomberg. Above are the default assumptions for senior unsecured credit. (c) Recovery rate is the standard assumption for senior unsecured CDS. 
Derivative 
Amount 
Classification 

Derivative 1 
$(1,000) 
Liability 

Derivative 2 
1,500 
Asset 

Derivative 3 
(2,000) 
Liability 

$(1,500) 
Net liability 
Derivative 1 
$(1,000) 
Divided by net position 
(1,500) 
Allocation percentage 
66.66% 
Multiplied by total credit risk adjustment 
150 
Allocated credit risk adjustment 
$100 
Derivative 1 
$(1,000) 
Divided by total liability position 
(3,000) 
Allocation percentage 
33.33% 
Multiplied by total credit risk adjustment 
150 
Allocated credit risk adjustment 
$50 
Derivative 
Amount 
Classification 
Derivative 1

$(1,000)

Liability

Derivative 2

1,500

Asset

Derivative 3

(2,000)

Liability

$(1,500)

Net liability

Derivative 1—Standalone credit risk 
$100 
Divided by total credit risk adjustment for all derivatives on a standalone basis (a) 
225 
Allocation percentage 
44.44% 
Multiplied by total credit risk adjustment 
150 
Allocated credit risk adjustment 
$67 
(a) Sum of the standalone credit risk adjustments for Derivate 1 ($100), Derivative 2 ($75), and Derivative 3 ($200). 
Relative fair value — method 1 
Relative fair value — method 2 
Relative credit adjustment 

Derivative 1 
$ 100 
$ 50 
$67 

Derivative 2 
(150) 
— 
(50) 

Derivative 3 
200 
100 
133 

Total adjustment 
$ 150 
$150 
$150 

Net asset adjustment 
$(150) 
— 
$ (50) 

Net liability adjustment 
$ 300 
$150 
$200 
Current 
Longterm 
Total 

Derivative 1 
$ 500 
$(1,500) 
$ (1,000) 

Derivative 2 
1,500 
— 
1,500 

Derivative 3 
(1,000) 
(1,000) 
(2,000) 

Net position 
$1,000 
$(2,500) 
$ (1,500) 
Derivative 1 – current position 
$500 
Divided by net position 
(1,500) 
Allocation percentage 
(33.33)% 
Multiplied by total credit adjustment 
150 
Allocated credit adjustment 
$(50) 
Derivative 1 – longterm 
$(1,500) 
Divided by net position 
(1,500) 
Allocation percentage 
100% 
Multiplied by total credit adjustment 
150 
Allocated credit adjustment 
$150 
Current 
Longterm 
Total 

Derivative 1 
$ (50) 
$150 
$ 100 

Derivative 2 
(150) 
— 
(150) 

Derivative 3 
100 
100 
200 

Total adjustment 
$(100) 
$250 
$ 150 

Net asset adjustment 
$(200) 
— 
$(200) 

Net liability adjustment 
$ 100 
$250 
$ 350 
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