Credit Risk Management Practice Exam

Which measure is associated with the potential future exposure in credit risk?

1. Expected Positive Exposure

2. Potential Future Exposure

3. Negative Expected Exposure

4. Effective Expected EE

The correct answer is: Potential Future Exposure

The measure associated with the potential future exposure in credit risk is known as Potential Future Exposure (PFE). This term specifically refers to the estimated maximum credit exposure that can occur at a future point in time due to the potential changes in the value of relevant instruments. PFE is critical in understanding and managing credit risk as it helps quantify the maximum exposure that could be faced in unfavorable market conditions. This measure is particularly valuable for financial institutions as they assess their risk in derivatives and other financial contracts, where markets can be volatile. By estimating PFE, firms can make more informed decisions regarding their capital reserves and risk management strategies, ensuring they remain resilient against potential losses. The other measures referenced do not directly address potential future exposure in the same specific context. For example, Expected Positive Exposure typically relates to the average exposure at future dates but does not reflect maximum exposure under worst-case scenarios like PFE does. Other options, such as Negative Expected Exposure and Effective Expected EE, do not capture the essence of measuring potential future risks in the same way.