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Answer: PFE of cross-currency swap
## Explanation The uppermost concave plot line most likely represents the **PFE of a cross-currency swap**. ### Reasoning: 1. **Cross-currency swaps** have the highest potential future exposure because they involve: - Exchange of principal amounts in different currencies at initiation and maturity - Periodic interest payments in different currencies - Currency risk in addition to interest rate risk - This creates significant exposure throughout the life of the swap 2. **Interest rate swaps (IRS)** typically have a hump-shaped exposure profile: - Lower exposure initially as few payments have been made - Peak exposure in the middle of the swap term - Declining exposure toward maturity as fewer payments remain 3. **FX forward contracts** have: - Increasing exposure over time as the spot rate can deviate more from the forward rate - Typically a concave upward shape - But generally lower overall exposure than cross-currency swaps 4. **Average PFE of IRS** (AWCE) would be a smoothed version of the IRS profile, not the uppermost concave line. The cross-currency swap combines both interest rate and currency risks, resulting in the highest and most pronounced concave exposure profile among these instruments.
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The chart below shows three exposure profiles, where the exposure metric is the potential future exposure (PFE): PFE of an interest rate swap (IRS), PFE of a foreign exchange (FX) forward contract, and PFE of a cross-currency swap. Also plotted is the average PFE of the interest rate swap, where "average PFE" is what Jorion calls the average worst credit exposure (AWCE). Which position's (instrument's) exposure profile is most likely the uppermost, concave plot line?
A
PFE of interest rate swap
B
PFE of foreign exchange (FX) contract
C
PFE of cross-currency swap
D
Average PFE of interest rate swap
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