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

A risk manager uses a linear relationship to propagate a stress shock. Factor X (an equity index) is shocked by -20%. Historically, factor Y (a credit spread change in bp) has a beta to X of -5 bp per 1% move in X, and X has a standard deviation of 4% with Y a standard deviation of 30 bp. Using the conditional expected move of Y given the shock to X, what is the implied change in Y?

The implied change in the credit spread is +100 bp. The conditional expected move equals beta times the shock: -5 bp per 1% multiplied by -20% gives +100 bp, meaning spreads widen as equities fall. A negative answer would reflect a sign error.

  1. A-100 bp
  2. B+100 bpCorrect
  3. C+20 bp
  4. D+25 bp

Explanation

Conditional expectation is beta times the shock: -5 bp per 1% times -20% = +100 bp. Spreads widen when equities fall. Choice -100 bp has the wrong sign; the others wrongly scale using the standard deviations (for example 30/4 ... or 20 x 1).

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