FRM II-Counterparty
Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm

FRM II-Counterparty

Postby » Wed Nov 05, 2014 5:29 pm

For a portfolio of derivative contracts, Analyst Jane wants to estimate her firm's counterparty exposure on a future target date, T(1), which is one year forward. For convenience, she assumes the future value of the portfolio at that time, T(1) has a normal distribution with a mean of zero (an equal likelihood of a gain/ITM or loss/OTM on the position) and standard deviation of $3.0 million. Of course, Jane realizes this is an unrealistic assumption and that a Monte Carlo simulation is unlikely to produce a forward normal distribution! Nevertheless, consider the following two statements:
I. The Expected Exposure, EE[T(1)], is equal to zero
II. The Potential Future Exposure, PFE[T(1)], with 99.0% confidence, is almost $7.0 million
Which is (are) true?
a) Neither
b) I. is true
c) II is true
d) Both are true

The expected future value is equal to zero, but the expected exposure is an average of only the positive values (the gains); that is, expected exposure is a conditional average. Therefore, it must be higher than the expected future value; in this case, EE(T) = +$1.20 million.
The PFE(T) is similar to VaR (except it refers to gains, not losses, as gains create credit exposure!) such that PFE(T) = 2.33*$3.0 = $6.99 million.

I dont understand how they got 1.2 million

Finance Junkie
Posts: 981
Joined: Wed Apr 09, 2014 6:28 am

FRM II-Counterparty

Postby edupristine » Thu Nov 06, 2014 12:17 pm


Expected positive exposure = 0.27* Standard Deviation* [Square root(T)]

= 0.27* 2.33 * SQRT (365) = 1.201894 million

Return to “FRM Part II”



Global Association of Risk Professionals, Inc. (GARP®) does not endorse, promote, review or warrant the accuracy of the products or services offered by EduPristine for FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP® is not responsible for any fees or costs paid by the user to EduPristine nor is GARP® responsible for any fees or costs of any person or entity providing any services to EduPristine Study Program. FRM®, GARP® and Global Association of Risk Professionals®, are trademarks owned by the Global Association of Risk Professionals, Inc

CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by EduPristine. CFA Institute, CFA®, Claritas® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Utmost care has been taken to ensure that there is no copyright violation or infringement in any of our content. Still, in case you feel that there is any copyright violation of any kind please send a mail to and we will rectify it.