Skip to content

FRM Part II · FRM Exam Part II · Credit Risk

A risk analyst compares the expected exposure (EE) profile over time of a 10-year uncollateralized, at-the-money interest rate swap with that of a 10-year zero-coupon bond held as an asset. Which statement best describes the swap's profile?

The swap's expected exposure is hump-shaped. Early on, growing uncertainty in rates increases potential value, but later the shrinking number of remaining payments (amortization) outweighs this, so exposure falls toward zero at maturity, unlike a zero-coupon bond whose exposure rises to par.

  1. AIt rises initially as uncertainty grows, then declines as the remaining payments shrink toward maturity, giving a hump shape.Correct
  2. BIt is constant over the life of the swap equal to the notional.
  3. CIt rises steadily and reaches its maximum on the final day.
  4. DIt is zero throughout because the swap has zero initial value.

Explanation

For a swap, the diffusion effect widens the range of possible values over time, increasing exposure, while the amortization effect reduces the remaining cash flows to be exchanged. Together they produce a hump. A bond's exposure instead rises toward par at maturity, which is the distractor about a steadily rising profile.

Did you get it right without looking?

One question tells you little. A timed set on Credit Risk shows your real accuracy, how long you take and where you lose marks.

Practise Credit RiskFree diagnostic mock

More Credit Risk questions