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FRM Part II · FRM Exam Part II · Future Value and Exposure

A risk manager notes that for a bank's portfolio of at-the-money forward contracts with a counterparty, the EPE is used in regulatory capital via a multiplier (alpha) applied to effective EPE. What is the primary purpose of this multiplier?

The alpha multiplier scales effective EPE to capture wrong-way risk, imperfect portfolio granularity and model uncertainty, since exposure and default may be correlated. It is not a time-horizon conversion, nor does it remove netting or only adjust for collateral haircuts.

  1. ATo convert exposure from a one-year to a ten-day horizon
  2. BTo account for wrong-way risk and the effect of exposure and default correlation, and for model uncertainty and portfolio granularityCorrect
  3. CTo remove the benefit of netting agreements from the exposure
  4. DTo adjust exposures for collateral haircuts only

Explanation

Alpha (supervisory value 1.4) scales effective EPE to reflect that exposures and defaults may be correlated (wrong-way risk), that portfolios are not perfectly granular, and that models are uncertain. It is not a horizon conversion, a netting removal, or a haircut adjustment.

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