Credit Risk Management Practice Exam

What does Peak Exposure measure in terms of counterparty risk?

1. The overall market potential exposure

2. The distribution of exposures at a high percentile

3. The expected positive exposure over time

4. The current exposure at the moment of default

The correct answer is: The distribution of exposures at a high percentile

Peak Exposure is a measure that focuses on the maximum potential loss that might be incurred from a counterparty during a specific time frame, particularly looking at high percentile distributions of exposure. It helps risk managers understand how much credit risk they are exposed to in extreme scenarios, allowing them to prepare for adverse conditions where exposures could be significantly higher than average. By examining the distribution at a high percentile, organizations can identify their worst-case scenarios, which are critical in stress testing and risk management strategies. This nuanced understanding of potential exposure aids in deciding the needed capital reserves or hedging strategies to mitigate risks effectively. In contrast, the other options address different aspects of counterparty risk. The overall market potential exposure reflects broader market risks rather than specific exposures at extremes. Expected positive exposure over time takes a forward-looking perspective on average exposure rather than peak values. Current exposure at the moment of default is a snapshot measurement, which does not account for potential peaks over time. Thus, the focus on high percentiles in Peak Exposure provides unique insights that are essential for managing counterparty risk effectively.