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Answer: Use a full-revaluation approach to model the bank's complex derivative exposures.
**A is correct.** "BHCs should generally use 'full-revaluation' methods for stress testing, given the very large risk factor moves, especially for nonlinear positions with value dependent on multiple risk factors". **B is incorrect.** Early warning indicators should be used based on the firm's risk profile. **C is incorrect.** "BHCs should recognize that their ability to take mitigating actions may be more limited in the stress scenario. For example, it may not be reasonable to assume that BHCs can easily sell their positions to other BHCs under the stress scenario." This assumption would not be suitably conservative and could also have impacts on the long-term strategy and operating structure which the bank might not have envisioned. **D is incorrect.** This is a lagging practice as it does not segment loans into client types or exposure to risk factors, which could impact the loss given default calculation.
Author: LeetQuiz .
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Risk analysts at a large bank have been asked to implement a stress testing procedure for a newly mandated regulatory stress test. The stress test requires that the bank project its revenues, losses, and capital ratios for each 3-month period over a 2-year horizon. Which of the following actions or assumptions should the analysts recommend for the stress test that is consistent with best practices?
A
Use a full-revaluation approach to model the bank's complex derivative exposures.
B
Use minimum required regulatory capital ratios as the initial trigger for potential contingency capital actions to be taken.
C
Assume that the bank will exit its riskiest lines of business and reduce its expenses during the stress test horizon period.
D
Model the loss given default of the bank's loan portfolio using a weighted-average approach at the aggregate portfolio level.