Maximum Potential Future Exposure [Credit B, slide 14]

[mikey10011]

I thought that your illustration of expected exposure and worst exposure using an "interest rate swap" on Credit B slides 10 & 11 were terrific! Question: does this *parabolic* shape (i.e., par at terminal value) apply to say, the "off-market yen-US dollar currency swap" on page 128 of Canabarro & Duffie? If not what does it say about the maximum potential future exposure [your screencast comments on slide 14]?

 

[David Harper CFA FRM]

Hi Mikey,

Thanks truly for liking the illustration. BTW, if you want to see it "in action," I uploaded the underlying spreadsheet here on the member page.. (on the third tab forward are the charts i generated for the PPT).

When I get time, I'll add a currency swap. Great idea!

Re the currency swap, the DIFFUSION EFFECT will still apply; i.e., the exposure will increase from 0 (at time 0) going forward. However, unlike the interest rate swap (which has a strong AMORTIZATION EFFECT, creating your parabolic shape), the currency swap exchanges principal at the end (maturity). Generally, therefore a FX swap will DIFFUSE with little/modest AMORTIZATION such that:

* Regarding an interest rate swap, the max PFE curve likely peaks 1/3rd (i.e., Jorion under his assumptions) to 2/3rd (other process assumptions)
* Regarding a currency swap, the max PFE likely peaks near/at maturity

David