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

A bank has a stress test for a netting set with a counterparty. Baseline exposure is 40 million, the stressed market scenario raises it to 100 million, and the bank holds 30 million of collateral under a CSA in the stressed state. The counterparty's stressed loss given default is 60% and its stressed default probability is 8%. Assuming collateral is fully effective and exposure net of collateral is used, what is the stressed expected loss?

The stressed expected loss is 3.36 million. Exposure net of collateral is 100 minus 30, or 70 million. Multiplying by the stressed default probability of 8% and loss given default of 60% gives 70 x 0.08 x 0.60, which equals 3.36 million.

  1. A3.36 millionCorrect
  2. B4.80 million
  3. C2.52 million
  4. D1.68 million

Explanation

Net exposure = 100 - 30 = 70 million. Expected loss = 70 x 0.08 x 0.60 = 3.36 million. The 4.80 million answer ignores collateral (100 x 0.08 x 0.6). The 2.52 million answer uses the wrong LGD of 45%, and 1.68 million uses a 4% default probability.

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