Question: QUESTION 2: You have been provided with a side showing the calculation of adjusted exposure. Assume XYZ Company enters into an interest rate swap contract

QUESTION 2: You have been provided with a side showing the calculation of adjusted exposure. Assume XYZ Company enters into an interest rate swap contract with Omega Bank that provides that XYZ will pay a floating rate of interest (assume LIBOR + 1%) and receive a 5% fixed rate of interest. This interest rate swap is intended to be a hedge of an XYZ floating rate liability.

Describe the methodology to calculate gross exposure for the interest rate swap. Hint: Discuss the concept of dynamic credit exposure as applied to interest rate swaps.

What are the pros and cons of using gross exposure vs. adjusted exposure in measuring credit risk on THIS TRANSACTION.

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