QUESTION 3:

Suppose that a bank has entered into a forward contract to buy 1 million ounces of platinum from a mining company in two years for $4,500 per ounce. The current forward price for the contract is $5,000 per ounce. The probability of the company defaulting during the first year is 2% and the probability of the company defaulting during the second year is 5%. Defaults are assumed to happen at the midpoints of the years. The risk-free rate is 6% per annum. The financial institution anticipates a 40% recovery in the event of a default. The volatility of the forward price of platinum when the forward contract expires in two years is 20%.

Calculate CVA and the value of the contract after accounting for default.

The BCBS has introduced a reform in 2017 for the CVA framework as part of Basel 3. Provide a summary of the main points of this reform.