Credit Exposure Profiles of Bonds and Loans
Bonds and loans have quite simple exposure profiles. The initial exposure is the face value of the bond or the amount of the loan. The exposure then varies as payments become due and are paid.
Let’s consider the exposure profiles of two financial products: a coupon-paying bond, and an amortizing loan. The profiles are shown below.
Consider a 10-year coupon paying bond with a $1,000 notional and a coupon of 6%. The bond will pay a 6%, or $60 coupon every year for the first nine nears and then make a final payment of $1,060 at the end of 10th year.
As you can see the exposure increases gradually as the payment becomes dues and drops when the payment is received. It’s called the “sawtooth” pattern. Since the largest payment is the principal payment of $1000 and the final coupon payment of $60, which is paid at the end of the bond period. To simplify, the exposure is generally assumed to be constant set at a certain average level (such as between coupon dates, in this case $1,030).
Unlike a coupon-paying bond, in an amortizing loan the loan principal is paid back gradually as a part of EMI over the life of the loan. The exposure profile is downward sloping with a ‘sawtooth’ as payments become due and are received.