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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A fund's board reviews its stress-testing governance. Which practice is most consistent with effective use of stress tests in capital planning?

Effective practice reports stress results to senior management and the board and ties them to predefined actions when losses exceed risk appetite limits. This integrates stress testing into capital planning, whereas isolating results, letting portfolio managers pick scenarios, or using static annual scenarios weakens its usefulness.

  1. AStress test results are reviewed only by the risk team and not escalated
  2. BScenarios are chosen by portfolio managers to reflect outcomes they consider plausible given their positions
  3. CResults are reported to senior management and the board, with defined actions triggered when stress losses exceed risk appetite limitsCorrect
  4. DStress tests are run once a year and the scenarios stay unchanged for consistency

Explanation

Effective stress testing is integrated into decision-making: results go to senior management and board and are linked to actions when limits tied to risk appetite are breached. Portfolio-manager-selected scenarios create bias, and static annual tests become stale.

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