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

A risk manager compares the potential future exposure (PFE) profiles of a 5-year cross-currency swap with a final notional exchange and a 5-year single-currency interest rate swap of the same notional. Which statement is most accurate?

The cross-currency swap has the larger exposure, peaking late in its life. Because the notional is exchanged at maturity, FX movements apply to the whole principal and there is no amortization effect, whereas the single-currency swap's exposure is small and humped.

  1. AThe cross-currency swap exposure peaks later and at a higher level, because the final notional exchange exposes the bank to FX moves on the full principalCorrect
  2. BThe interest rate swap has the higher exposure since it has more frequent cash flows
  3. CThe two profiles are identical because both have the same notional
  4. DThe cross-currency swap has lower exposure because FX volatility is smaller than interest rate volatility

Explanation

In a cross-currency swap the principal is exchanged at maturity, so FX moves act on the full notional and the exposure does not amortize. The profile grows toward maturity, with a peak late in life. The single-currency swap has no principal exchange, so its profile is humped and much lower.

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