Funding cost adjustments for derivatives

A paper discussing the relationship of the funding cost adjustment to the balance sheet and demonstrating two ways in which the funding cost adjustment can be eliminated

Funding costs and the bilateral counterparty credit risk of derivatives positions have become increasingly hot topics since the beginning of the credit crisis in 2008. It has become standard practice to adjust derivatives prices for the counterparty risk.

Similarly, funding costs are increasingly incorporated into derivatives prices one way or another, but the conceptual foundations for such funding adjustments are much less well understood.

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