FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction
An equity index has monthly volatility of 5%. A credit spread factor has monthly volatility of 20 bps and correlation of -0.60 with the equity index. Assuming zero means and joint normality, what is the conditional expected spread change if equity falls 10% (a -10% shock)?
The conditional expected spread widening is +24 bps. The beta is correlation times the ratio of volatilities: -0.6 times 20/5 gives -2.4 bps per 1% equity move, and a 10% fall multiplies that by -10, giving +24 bps.
- A+24 bpsCorrect
- B+12 bps
- C-24 bps
- D+48 bps
Explanation
Beta = rho x sigma_Y / sigma_X = -0.6 x 20/5 = -2.4 bps per 1%. Times a -10% shock = +24 bps. +12 would use 5% shock; -24 has the wrong sign; 48 ignores the correlation.
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