A bank has AED80 million in trades with a counterparty. The bank currently has met all past variation margin (VM) calls, so the value of trades with the counterparty is offset by cumulative VM in the form of cash collateral received. Furthermore, an “Independent Amount” (IA) of AED 10 million was agreed in favour of the bank, and none in favour of its counterparty. This leads to a credit support amount of AED 90 million (80 million plus 10 million), which is assumed to have been fully received as of the reporting date. There is a small “Minimum Transfer Amount” (MTA) of AED1 million, and a “Threshold” (TH) of zero.

In this example, the V-C term in the replacement cost (RC) formula is zero, since the value of the trades is more than offset by collateral received; AED80 million – AED90 million = -10 million. The term (TH + MTA - NICA) is -9 million (0 TH + 1 million MTA - 10 million of NICA held). Using the replacing cost formula:

RC = MAX {(V-C), (TH+MTA-NICA), 0}

= MAX{(80-90),(0+1-10),0}

= MAX{-10,-9,0} = 0
 

Because both V-C and TH+MTA-NICA are negative, the replacement cost is zero. This occurs because of the large amount of collateral posted by the bank’s counterparty.