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

A bank's counterparty credit risk team builds a Monte Carlo engine to estimate the future exposure of a portfolio of interest rate swaps with one counterparty. Which sequence best describes the standard process?

The standard approach simulates risk factor paths across a grid of future dates, revalues the netting set on every path and date, takes the positive part of the value as exposure, and then computes expected exposure or PFE across paths at each date.

  1. ASimulate risk factor paths over future dates, revalue the netting set at each date on each path, floor values at zero, then take statistics across paths at each dateCorrect
  2. BSimulate only the final maturity value of each risk factor, revalue once, and scale the result by the square root of time
  3. CCompute current mark-to-market and multiply by a fixed add-on percentage for each future date
  4. DSimulate default times only and record the portfolio value at the default date without revaluing trades

Explanation

Exposure simulation generates scenarios of the underlying risk factors at a grid of future dates, reprices the netting set on each scenario, applies max(V,0) to get exposure, and then computes statistics such as EE and PFE across paths per date. Single-date simulation or fixed add-ons do not produce a full exposure profile.

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