Pre-settlement risk is the risk that one of the counterparties defaults prior to the date for the maturity of the transaction in question. This may be an unrelated default, in fact there may have been no default on that particular contract, but the party may have defaulted on its other obligations, or filed for bankruptcy. To deal with such cases and to protect the interests of both the parties, it is common toprovide for immediate termination of positions and settlement based on the current replacement value of the contracts. Therefore statements I and II are correct.

Statement III is correct as well - the exposure from an OTC derivative contract derives fromits current replacement value, and not the notional. If the current replacement value is negative, then the credit exposure is considered equal to zero.

Statement IV is correct as it is quite common to restate all exposures - those from credit lines, OTC derivatives etc - in loan equivalent terms prior to estimating credit risk.