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

A bank's counterparty stress test uses a severe scenario with stressed exposure at default of USD 50 million to a hedge fund. Collateral held is USD 20 million before a 25% stress haircut, and the loss given default on the unsecured remainder is 60%. Counterparty default is assumed in the scenario. What is the stressed loss?

The stressed loss is USD 21.0 million. Collateral falls to USD 15 million after the 25% haircut, leaving USD 35 million unsecured, and a 60% loss given default on that amount gives USD 21.0 million. Ignoring the haircut would understate the loss at USD 18 million.

  1. AUSD 18.0 million
  2. BUSD 21.0 millionCorrect
  3. CUSD 12.0 million
  4. DUSD 27.0 million

Explanation

Stressed collateral = 20 × (1 − 0.25) = 15 million. Unsecured exposure = 50 − 15 = 35 million. Loss = 35 × 0.60 = 21.0 million. Ignoring the haircut gives 30 × 0.6 = 18; applying the haircut in the wrong direction (25 collateral) gives 25 × 0.6 = 15; losing 27 would come from other errors.

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