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

A bank's risk team reviews exposure metrics for a portfolio of uncollateralised interest rate swaps with a single counterparty. Which description correctly defines Potential Future Exposure (PFE) at a 97.5% confidence level for a given future date?

PFE at 97.5% is the 97.5th percentile of the exposure distribution at a given future date. It measures a high-confidence worst-case exposure, used for limits. The mean of positive exposures is expected exposure, and its time average is EPE, so those options describe different measures.

  1. AThe average of all positive exposures across simulated paths at that date
  2. BThe 97.5th percentile of the distribution of exposure at that dateCorrect
  3. CThe average of expected exposure over the life of the portfolio
  4. DThe highest exposure observed on any path at any date over the portfolio life

Explanation

PFE is a high quantile of the exposure distribution at a specific future date, so 97.5% PFE is the 97.5th percentile. The average of positive exposures is Expected Exposure (EE), and the average of EE over time is Expected Positive Exposure (EPE). The maximum across all paths and dates is not a quantile-based PFE.

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