Skip to content

FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction

A portfolio has exposures to equities (factor 1) and credit spreads (factor 2). The scenario shocks equities by -20%. Historical analysis gives a conditional relationship in which the expected credit spread change given the equity move is 0.5 percentage points per -10% equity move, i.e. a linear beta of -0.05 pp per 1% equity change. The portfolio loses 0.9% of value per 1% fall in equities and 3.0% of value per 1 pp rise in spreads. What is the total scenario loss as a percentage of portfolio value?

The equity shock costs 18.0% (20 times 0.9). The implied spread widening is 1.0 percentage point (20 times 0.05), costing a further 3.0%. The total scenario loss is 21.0% of portfolio value. Ignoring the correlated spread move would understate the loss at 18.0%.

  1. A18.0%
  2. B21.0%
  3. C33.0%Correct
  4. D19.5%

Explanation

Equity loss = 20 x 0.9 = 18.0%. The implied spread rise = 20 x 0.05 = 1.0 pp, giving 1.0 x 3.0 = 3.0%. The total is 21.0%... check: 18.0 + 3.0 = 21.0%, so the correct total is 21.0%.

Did you get it right without looking?

One question tells you little. A timed set on Market-Driven Scenarios: An Approach for Plausible Scenario Construction shows your real accuracy, how long you take and where you lose marks.

Practise Market-Driven Scenarios: An Approach for Plausible Scenario ConstructionFree diagnostic mock

More Market-Driven Scenarios: An Approach for Plausible Scenario Construction questions