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

A risk manager compares the 95% potential future exposure (PFE) profiles for a 5-year payer interest rate swap and a 5-year forward on a commodity with a single final settlement, same notional and driven by comparable volatility. Assume no collateral. Which conclusion is most appropriate?

A forward with a single final settlement has PFE that keeps increasing until maturity because there is no amortization, whereas a swap's periodic payments reduce remaining risk, so its PFE peaks earlier and then declines. Near maturity, the forward's exposure is typically larger.

  1. ABoth have identical profiles because volatility is the same
  2. BThe swap's PFE peaks at maturity while the commodity forward's declines
  3. CThe commodity forward's PFE grows to a maximum at maturity while the swap's PFE peaks earlier and declines, so the forward's exposure is typically greater near maturityCorrect
  4. DNeither has any PFE because both start at zero value

Explanation

A single-settlement forward has no intermediate cash flows to amortize, so uncertainty in value grows roughly with the square root of time until maturity. The swap's periodic payments reduce remaining exposure, creating a hump. Starting at zero value does not remove future exposure.

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