The present value of the expected future net cash flows of a derivative. This value captures the current credit exposure of a derivative transaction, i.e., its market value. The calculation of this cost is based on the assumption that the exposure associated with a defaulted transaction is closed out by entering into a replacement transaction with a different counterparty. In this sense, this cost is the recovery amount that will be received from the defaulting counterparty (for a positive net value recovery) or that will be paid to such a party (for a negative net value recovery).

Other key assumptions for calculation include the existence of no correlation between the derivative credit exposure being measured and the probability of default as well as the existence of a liquid market in the derivative instrument. Examples of replacement cost is the cost that would be incurred to replace an interest rate swap position or option position.

Another measure of replacement cost is the so-called future replacement cost, which is estimated to provide a glimpse about potential credit exposure. For a given transaction, it is typically calculated using probability analysis based upon wide confidence intervals (e.g., 2 standard deviations) over the remaining time to maturity.