The Credit Valuation Adjustment of an Interest Rate Swap Step-by-Step (Static Formulation)

Abstract

Counterparty credit risk (CCR) is a fundamental issue in the modern financial markets. CCR attempts to capture the impact of the potential losses due to the default (e.g. bankruptcy) of the counterparty in a financial operation. The most used quantitative measure of CCR is the Credit Valuation Adjustment (CVA ). In this laboratory, we show how to calculate the CVA of an interest rate swap in a simplified way. The approach we follow (Static Formulation) is to consider the interest rate yield curve to be static during the duration of the contract. In the next article, we will show how to extend this into a dynamic yield curve (Dynamic Formulation) using Monte Carlo simulation. We demonstrate our solution in Excel.