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

A bank stresses a netting set with current mark-to-market of USD 20 million, collateral held of USD 8 million, and a stressed potential increase in value of USD 15 million over the margin period of risk. In the stress, the counterparty defaults and the bank can liquidate collateral only at a 25% haircut. Ignoring other effects, what is the stressed exposure at default (current exposure net of haircut collateral, plus the stressed increase)?

Stressed exposure is USD 29 million. Collateral of USD 8 million is worth USD 6 million after the 25% haircut, so net current exposure is USD 14 million. Adding the USD 15 million stressed increase in value over the margin period gives USD 29 million.

  1. AUSD 29 millionCorrect
  2. BUSD 27 million
  3. CUSD 23 million
  4. DUSD 35 million

Explanation

Haircut collateral = 8 x (1 - 0.25) = 6. Net current exposure = 20 - 6 = 14. Adding the stressed increase of 15 gives 29. The option 27 ignores the haircut (20-8+15); 23 subtracts the full collateral and the haircut wrongly; 35 ignores collateral.

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