Skip to content

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

A dealer bank's counterparty stress test assumes that, in a severe market shock, the margin period of risk (MPOR) for a netting set with a hedge fund client lengthens from 10 business days to 20 business days. All else equal, what is the most direct effect on the stressed exposure estimate?

Stressed exposure rises. A longer margin period of risk means the portfolio value can move further between the last margin received and close-out, leaving a larger uncollateralized gap. Extending the period does not reduce exposure, since the defaulting counterparty posts no further margin during that time.

  1. AStressed exposure rises, because the collateral held lags the market value over a longer window of potential price movementCorrect
  2. BStressed exposure falls, because more variation margin calls are issued during the longer period
  3. CStressed exposure is unchanged, because the collateral agreement fixes the threshold
  4. DStressed exposure falls, because the longer close-out period gives more time to liquidate collateral

Explanation

The MPOR is the time between the last successful margin exchange and the close-out and replacement of the position. A longer MPOR means the portfolio value can move further before collateral is received, so the uncollateralized gap and the stressed exposure rise. Option B confuses call frequency with the lag, as no extra calls are received once the counterparty has defaulted.

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