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

A risk analyst at a bank is describing the exposure profile of a portfolio of uncollateralised derivatives with one counterparty. Which statement best defines potential future exposure (PFE) at a given future date?

Potential future exposure is a high percentile, such as 95% or 99%, of the distribution of positive future exposure at a given date. It measures a worst-case exposure at that confidence level, unlike expected exposure, which is the average of the positive exposures.

  1. AThe average of all positive and negative mark-to-market values at that date
  2. BA high-percentile (for example 95% or 99%) of the distribution of positive exposure at that dateCorrect
  3. CThe mean of the positive exposure distribution at that date, discounted to today
  4. DThe loss expected if the counterparty defaults, after applying the recovery rate

Explanation

PFE is a quantile of the future exposure distribution, measuring a worst-case exposure at a chosen confidence level. Averaging the positive exposure gives expected exposure, not PFE. Option 0 includes negative values, which are not exposure, and option 3 describes expected loss, which involves default probability and recovery.

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