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FRM Part II · FRM Exam Part II · Credit Risk Management

A risk manager reports the following for a portfolio of swaps with one counterparty over the next year: simulated exposure profile gives expected exposure (EE) of USD 6 million at month 3, USD 10 million at month 6, and USD 8 million at month 9. The 97.5th percentile exposure at month 6 is USD 22 million. Which measure does the USD 22 million figure represent, and how is it used?

It is potential future exposure. PFE is a high percentile, here 97.5th, of the simulated exposure distribution at a future date. It measures a worst-case-type exposure and is used mainly to set and monitor counterparty credit limits, unlike expected exposure, which is an average.

  1. APotential future exposure, used for setting credit limitsCorrect
  2. BExpected positive exposure, used for regulatory capital
  3. CEffective expected exposure, used for CVA pricing
  4. DNegative exposure, used for funding valuation adjustments

Explanation

A high percentile of the exposure distribution at a future date is potential future exposure (PFE), a tail measure used for limits. EE is the mean of positive exposure and is used for pricing CVA. The distractors name average-based or unrelated measures.

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