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FRM Part II · FRM Exam Part II · Future Value and Exposure

A bank has a 3-year forward contract to buy EUR against USD at a fixed rate. A risk analyst compares its exposure profile with that of a 3-year interest rate swap of the same notional in the same currency pair environment. Which statement is most accurate?

The FX forward's exposure keeps rising and peaks near maturity. It has a single exchange at the end, so nothing amortises along the way, and the growing uncertainty in the exchange rate dominates, unlike a swap where periodic payments cause exposure to decline later.

  1. AThe FX forward's exposure peaks near maturity because there is no intermediate exchange of cash flows to reduce itCorrect
  2. BThe FX forward's exposure peaks at the midpoint because of amortisation
  3. CThe FX forward has zero exposure because it is settled only at maturity
  4. DThe FX forward's exposure is always lower than the swap's because FX volatility is lower than rate volatility

Explanation

An FX forward has a single exchange at maturity, so no amortisation occurs and the diffusion effect keeps increasing exposure until the end. A swap, with periodic payments, has a hump shape. The claim of zero exposure ignores mark-to-market value before settlement.

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