General Studies · Counterparty Credit Risk
When assessing Counterparty Credit Risk (CCR) for over-the-counter (OTC) derivative transactions, banks calculate 'Potential Future Exposure' (PFE). This metric is specifically designed to capture:
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- 1The potential increase in exposure over a specified time horizon until the end of the contract, due to future market fluctuations.✓
- 2The risk that the bank's own credit rating will be downgraded, leading to higher funding costs.
- 3The total value of collateral already held in a segregated account to cover the current mark-to-market value.
- 4The current loss that would be incurred if a counterparty defaulted immediately, known as the replacement cost.
Correct answer
The potential increase in exposure over a specified time horizon until the end of the contract, due to future market fluctuations.
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