Current exposure Vs Potential Exposure Vs Peak Exposure

[[email protected]]

Hi David,

2004 past year question
The answer states that credit risk manager will uses a combination of current exposure, potential exposure and peak exposure to determine the amount of credit risk in derivative transaction.

Could you explain further on what is current exposure, potential exposure and peak exposure? Thanks.

Regards
Learning

 

[David Harper CFA FRM]

Hi Learning,

Can you see the second part of this tutorial: http://www.bionicturtle.com/premium/screencast/2009_6.a_credit_risk/
...where I review Canabarro's reading on "Measuring and marking counterparty risk"

see snapshot (p47/70):

http://learn.bionicturtle.com/images/forum/nov13_ece.png

Theses are counterparty credit credit exposure concepts: expected credit exposure (ECE)
and worst credit exposure, WCE (jorion's term) which is same as potential future exposure (PFE)
... the key here is that, instead of traditional loans where principal is the exposure, here we are dealing with derivatives (bilateral contracts) and since value can be -/+/0, we simulate the future exposure then, to get PFE, apply a VaR concept (i.e., what that's 95% worst future exposure). Jorion:

"Current exposure: replacement cost of derivatives transactions, that is, their market value
"Potential exposure: an estimate of the future replacement cost of derivatives transactions"

David