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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. Current exposure is 40 million. Under a stress scenario the mark-to-market of the netting set rises to 100 million, and the counterparty's collateral held falls from 30 million to 20 million because of a haircut increase. The stressed loss given default is 60% and the stressed one-year default probability is 5%. Treating stressed exposure as the stressed MtM less collateral, what is the stressed expected loss?

Stressed exposure is 100 million MtM less 20 million collateral, or 80 million. Multiplying by the 5% default probability and 60% loss given default gives a stressed expected loss of 2.4 million. Using unstressed collateral or unstressed exposure would understate the loss.

  1. A2.4 millionCorrect
  2. B1.8 million
  3. C0.72 million
  4. D3.0 million

Explanation

Stressed exposure = 100 - 20 = 80 million. Expected loss = 80 x 5% x 60% = 2.4 million. Using the original 30 million collateral gives 70 x 0.03 = 2.1 only if LGD is 60%, which is not an option; 1.8 comes from 60 x 5% x 60%, and 0.72 from using 40 less 30 etc. with wrong exposure.

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