The PFE profile of a plain vanilla interest rate swap typically has a bell-shaped curve. This is because the exposure starts low, peaks in the middle of the swap's life when the uncertainty about future interest rate movements is the highest, and then decreases as the swap approaches its maturity and the remaining payments become fewer and smaller.

A is incorrect because an equity-linked note, which has payoffs linked to an underlying equity instrument, usually exhibits a non-linear exposure profile due to the inherent volatility and price dynamics of the underlying equity.

B is incorrect because an interest rate cap, which provides a ceiling on interest rates for a borrower, generally shows a skewed exposure profile. Its exposure increases in scenarios where interest rates rise above the cap level, but this does not typically form a bell-shaped curve.

D is incorrect because a credit default swap (CDS) on a corporate bond primarily has a risk exposure profile that reflects the credit risk of the underlying corporate bond. The profile of a CDS is more likely to be influenced by credit events and does not typically exhibit a bell-shaped curve.

Things to Remember

• Interest rate swaps involve exchanging one stream of future interest payments for another.