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

A bank has a 5-year cross-currency swap with exchange of notional at maturity, and an otherwise identical 5-year interest rate swap in a single currency. Which statement about their exposure profiles is most accurate?

The cross-currency swap's exposure usually keeps rising and peaks near maturity, because the principal exchanged at the end is exposed to FX movements that accumulate with time and there is no offsetting amortization, unlike a single-currency interest rate swap.

  1. AThe cross-currency swap's exposure typically peaks near maturity because of the final notional exchange and FX volatilityCorrect
  2. BBoth profiles are hump-shaped with identical peak timing
  3. CThe interest rate swap has higher exposure because rate volatility exceeds FX volatility
  4. DThe cross-currency swap exposure is zero because notionals are exchanged at inception

Explanation

The final exchange of notionals in different currencies means FX moves on the large principal remain at risk until maturity, so there is no amortization effect. Exposure rises with time and tends to peak near maturity. A single-currency swap has hump-shaped exposure since cash flows run off.

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