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FRM Part II · FRM Exam Part II · Credit Value Adjustment

A risk manager compares two portfolios with the same current mark-to-market. Portfolio A is a 10-year receiver swap and Portfolio B is a 10-year cross-currency swap with a final notional exchange. Both are uncollateralised. Which statement about their expected exposure profiles is most accurate?

The interest rate swap's exposure typically rises and then falls as payments are made, giving a hump shape, while the cross-currency swap's exposure tends to keep rising until maturity because the large final notional exchange carries FX risk that grows with time.

  1. ABoth profiles peak at the end of the trade's life, because exposure always increases with maturity
  2. BPortfolio A's exposure typically rises then falls as cash flows amortise, while Portfolio B's profile typically keeps rising until maturity because of the final notional exchangeCorrect
  3. CPortfolio B's exposure is always lower, since exchanging notionals eliminates credit risk
  4. DBoth profiles are flat, since exposure depends only on the current mark-to-market

Explanation

A single-currency interest rate swap has no notional exchange, so exposure initially grows with rate uncertainty and then declines as remaining payments shrink (amortisation effect). A cross-currency swap has FX risk on a final notional exchange, so exposure tends to keep increasing toward maturity. The claim that all exposure peaks at maturity ignores the amortisation effect.

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