Valuing Derivatives: Funding Value Adjustments and Fair Value

The authors examined whether a bank should make a funding value adjustment (FVA) when valuing derivatives. They conclude that an FVA is justifiable only for the part of a company's credit spread that does not reflect default risk. They show that an FVA can lead to conflicts between traders and accountants. The types of transactions a bank enters into with end users will depend on how high its funding costs are. Furthermore, an FVA can give rise to arbitrage opportunities for end users.