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

A bank stress tests a counterparty with a one-way credit support annex under which only the bank posts collateral, and the counterparty posts none. Compared with a symmetric two-way agreement, how does the stress test most likely treat the bank's exposure to that counterparty?

Exposure is higher. Because the counterparty posts nothing, the bank has no collateral cover when its position is in the money, and any collateral the bank has posted may also be at risk if not segregated. Stress tests should therefore show larger losses than under a two-way agreement.

  1. AExposure is lower because the bank's own posting offsets the counterparty's default risk
  2. BExposure is higher because the bank receives no collateral against positive mark-to-market values, while its own posted collateral may also be at riskCorrect
  3. CExposure is unchanged because collateral terms do not affect exposure
  4. DExposure is zero because one-way agreements eliminate close-out risk

Explanation

Under a one-way agreement the bank gets no protection when its mark-to-market is positive, so uncollateralised exposure is larger. Any excess or non-segregated collateral the bank posts can itself be exposed to the counterparty's default.

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