June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 60 of 92 Utilizing this framework allows the user to determine the PFE at various confidence intervals for each counterparty. Analysis can also be executed at an aggregate level by grouping exposures by credit rating. Each view provides the user with insight into the overall credit exposure. At the basis of this approach is the market rate propagation process which will be discussed further in the Chapter 5, the Market Risk Chapter. The price propagation model used for this purpose should be identical to that used in measuring market risk and should reflect inter-temporal, inter-commodity, and basis correlations. Concerning the time horizon, evaluation dates should at least include several future dates that will meaningfully encompass the full maturity of most trades with sufficient frequency to catch any peaks around interim settlement dates. Failure to evaluate PFE with sufficient frequency or horizon length can result in a significant underestimation of exposure. Consistent with the Credit Risk Measurement Framework displayed in Figure 5.1, the PFE can be calculated both with and without such mitigation measures as: Commodity Foreign Exchange Interest Rate Inflation Rates MARKET RISK COMPONENTS 10 Counterparty D 280 TOTAL 150 Counterparty C 100 Counterparty B 20 Counterparty A Current Exposure ($MM) Counterparty 10 Counterparty D 280 TOTAL 150 Counterparty C 100 Counterparty B 20 Counterparty A Current Exposure ($MM) Counterparty 0 0.005 0.01 0.015 0.02 0.025 0.03 $0 $9 $18 $27 $36 $45 $54 $63 $72 $81 $90 $99$108$117$126$135 0 0.005 0.01 0.015 0.02 0.025 0.03 $0 $9 $18 $27 $36 $45 $54 $63 $72 $81 $90 $99$108$117$126$135 0 0.005 0.01 0.015 0.02 0.025 0.03 $0 $9 $18 $27 $36 $45 $54 $63 $72 $81 $90 $99$108$117$126$135 0 0.005 0.01 0.015 0.02 0.025 0.03 $0 $9 $18 $27 $36 $45 $54 $63 $72 $81 $90 $99$108$117$126$135 Counterparty A PFE Counterparty B PFE Counterparty C PFE Counterparty D PFE