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

A portfolio holds an $80 million equity position with delta 1 to the equity index. It also has a credit spread sensitivity (CS01) of a $50,000 loss per 1 bp widening. In the scenario, the equity index falls 15%. The index has a standard deviation of 10%, spreads have a standard deviation of 40 bp, and their correlation is -0.5. Using conditional expected spread moves, what is the scenario loss?

The scenario loss is $13.5 million. The equity fall costs $12.0 million, and the conditional spread widening of 30 bp costs a further $1.5 million at $50,000 per bp. Both legs lose, so they add.

  1. A$13.5 millionCorrect
  2. B$12.0 million
  3. C$10.5 million
  4. D$15.0 million

Explanation

The spread move is -0.5 x (40/10) x (-15) = +30 bp. The equity loss is 80 x 15% = $12.0m and the credit loss is 30 x $50,000 = $1.5m, so the total is $13.5m. Ignoring the spread leg gives $12.0m. Treating the spread leg as a gain gives $10.5m.

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