Skip to content

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

A bank's stress test on a portfolio of derivatives counterparties indicates that the loss would come mainly from wrong-way risk with a few concentrated counterparties during a market-wide shock. Which use of this result is most consistent with effective management action?

The bank should tighten concentration limits and revise collateral and margin terms for the affected counterparties. A stress test showing concentrated wrong-way risk is only useful if it drives action on limits and mitigants, whereas lowering confidence levels or dropping the test would hide the risk.

  1. AUse the result only to calculate the regulatory capital floor
  2. BLower the confidence level of the internal exposure model to reduce reported exposure
  3. CSet or tighten concentration limits and revise collateral and margin terms for the affected counterpartiesCorrect
  4. DDiscontinue the stress test since the normal VaR-based exposure measure already covers these counterparties

Explanation

Stress results showing concentrated wrong-way risk should drive limits and collateral terms, which address the identified vulnerability. Lowering the confidence level would reduce visibility of risk, and normal exposure models generally do not capture such tail dependence. Using the result only for a capital floor ignores management action.

Did you get it right without looking?

One question tells you little. A timed set on The Evolution of Stress Testing Counterparty Exposures shows your real accuracy, how long you take and where you lose marks.

Practise The Evolution of Stress Testing Counterparty ExposuresFree diagnostic mock

More The Evolution of Stress Testing Counterparty Exposures questions