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FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures

A bank has a netting agreement with a counterparty covering two OTC trades. Under a stress scenario, trade A has a mark-to-market of +USD 40 million and trade B has -USD 25 million to the bank. No collateral is held. If the netting agreement is found unenforceable in the counterparty's jurisdiction, by how much does stressed exposure increase compared with the enforceable-netting case?

Exposure rises by USD 25 million. With enforceable netting the exposure is USD 15 million (40 minus 25), while without netting the bank is exposed to the full USD 40 million on the positive trade, so the loss of netting adds USD 25 million.

  1. AUSD 0 million
  2. BUSD 10 million
  3. CUSD 25 millionCorrect
  4. DUSD 40 million

Explanation

With enforceable netting, exposure is max(40-25,0)=USD 15 million. Without netting, exposure is the sum of positive values: USD 40 million (trade B's negative value gives no offset). The increase is 40-15=USD 25 million. USD 40 million confuses the gross exposure with the increase.

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