What is Potential Future Exposure (PFE)? Explain.

Question

Accepted Answer

PFE stands for Potential Future Exposure, which is a measure of the maximum expected loss on a portfolio due to market movements.

PFE is used in risk management to assess the potential impact of adverse market movements on a portfolio.
It helps in determining the amount of capital that needs to be set aside to cover potential losses.
PFE is calculated using statistical models and simulations to estimate the maximum loss that could occur within a certain confidence level.
It is an important metric for financial institutions to manage market risk effectively.
Example: If a bank has a PFE of $10 million on a certain portfolio, it means that there is a 95% confidence level that the maximum loss will not exceed $10 million.