PFE = Potential Future Exposure

Potential future exposure is a measure of risk in relation to default by a counter-party to a financial transaction. It begins from the assumption that the transaction is proving beneficial to the party concerned and then calculates the potential loss should the counter-party default.

PFE is actually derived from mark-to-market and revaluing the portfolio and considered an estimate of MtM, but at a specific point in the future. Similar to VaR, PFE is also based on a high confidence level, taking into account the worst-case scenarios. The current MtM may follow a number of different possible paths into the future, so a probability distribution of PFE can be derived.