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

A bank has a netting set with a counterparty containing two trades. Trade A has a stressed mark-to-market of +USD 40 million and Trade B has -USD 25 million. The netting agreement is legally enforceable and there is no collateral. If instead the agreement were found unenforceable in the counterparty's jurisdiction, by how much would stressed exposure increase on a default?

Exposure rises by USD 25 million. With enforceable netting the exposure is 40 minus 25, or 15 million; without netting the bank's claim is the full 40 million on the positive trade while it still owes the negative trade, so the increase is 25 million.

  1. AUSD 15 million
  2. BUSD 25 millionCorrect
  3. CUSD 40 million
  4. DUSD 65 million

Explanation

With enforceable netting, exposure = max(40 - 25, 0) = 15. Without netting, the bank must pay the 25 owed on Trade B in full while claiming only a recovery on Trade A, so gross exposure is 40. The increase is 40 - 15 = 25. Distractor 15 is the net exposure itself; 65 adds absolute values.

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