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FRM Part II · FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

A bank's reverse stress test is being designed. Which describes the correct starting point and purpose of a reverse liquidity stress test?

A reverse stress test starts from a defined failure outcome, such as exhausting liquidity before the survival horizon ends, and works backward to identify the shocks and combinations that could cause it. This uncovers vulnerabilities that forward-looking, predefined scenarios may overlook.

  1. AStart from a defined severe market scenario and compute the resulting capital ratio
  2. BStart from the outcome of liquidity exhaustion or breach of the survival horizon and identify the events that could cause itCorrect
  3. CStart from regulatory minimum ratios and confirm they are met under baseline conditions
  4. DStart from historical average outflows and scale them by a fixed multiplier

Explanation

A reverse stress test begins with a defined failure outcome, such as exhausting liquidity within the survival horizon, and works backward to find the combinations of shocks that produce it. This reveals hidden vulnerabilities that forward scenarios may miss.

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