The bank from the previous example has the same portfolio, including the single-name hedge of Galaxy Financial, but now enters into an index CDS that provides credit spread protection against a basket of twenty named entities. The notional value of the index CDS is 300, with a maturity of 1.5 years. The bank’s calculation of CVA capital now takes into account the impact of an eligible index hedge, which reduces systematic CVA risk. The relevant form of the calculation from the Standards is:

Because the bank has only one index hedge, the summation for index hedges inside the calculation has only a single (W_ind H_ind DF_ind) term. As stated above, the notional value of the hedge is H_ind=300. The bank needs to calculate the appropriate supervisory discount factor for the index CDS, based on the maturity M_ind=1.5 years:

To determine the risk weight, the bank must determine the credit rating for each of the twenty reference names in the index basket, the corresponding risk weight for each rating (from Table 1 in the Standards), and the weighted average of those risk weights using the relative notional values of the component names for the weights. Suppose that through this process of analysis, the bank determines that the weighted average is 1.2% (slightly worse than BBB). As a result, W_ind=0.012. The impact of risk mitigation from the index CDS enters the calculation through the term:

W_indH_indDF_ind = 0.012 × 300 × 1.445 = 5.20

The bank can now calculate CVA capital, taking into account the impact of the index hedge that mitigates systematic risk. Many of the relevant values are unchanged from the previous example, but there is the addition of the index hedge effect on systematic CVA risk:

As before, the bank computes RWA for CVA using the multiplicative factor of 12.5as required in the Standards: