Question: Suppose that a bank buys an option from a client. The option is uncollateralized and there are no other transactions outstanding with the client. The

Suppose that a bank buys an option from a client. The option is uncollateralized and there are no other transactions outstanding with the client. The expected values of the option at the mid-point of years 1, 2, and 3 are 6, 5, and 4. The probability of the counterparty defaulting in each of the three years is 3%. The probability of the bank defaulting in each of the three years is 2%. What is the bank's CVA and DVA for the transaction. Assume no recovery in the event of default and zero interest rates.

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