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

A risk analyst at a bank is reviewing exposure metrics for an uncollateralised portfolio of derivatives with a single counterparty. Which statement best describes potential future exposure (PFE) at a given future date?

PFE is a high quantile, such as 97.5% or 99%, of the distribution of future exposure at a given date. It measures a plausible worst-case exposure at that confidence level, unlike expected exposure, which is the mean of positive values.

  1. AThe average of positive mark-to-market values at that date, discounted at the risk-free rate
  2. BA high quantile, such as 97.5% or 99%, of the distribution of exposure at that dateCorrect
  3. CThe maximum expected exposure over the life of the portfolio
  4. DThe expected exposure at that date multiplied by the counterparty's loss given default

Explanation

PFE is a high percentile of the exposure distribution at a future date, indicating a worst-case exposure at a chosen confidence level. The average of positive values is expected exposure (EE), and the maximum of EE over time is peak EE. Multiplying by LGD relates to expected loss, not PFE.

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