Question #1 of 12 Question ID: 746113

Which of the following would least likely be associated with conducting a stress test?

✗ A) Monte Carlo simulations that generate extreme values.

✗ B) Using one-percentile values of factors in an estimated factor analysis equation.

✗ C) Market values and relationships observed during the Crash of 1987.

✓ D) Modified VaR where kurtosis is three and skewness is zero.

Explanation

Stress tests use observed extreme values from historical data or generated extreme values from Monte Carlo
simulations. It would be counter productive to assume kurtosis and skewness are zero because such assumptions
would limit the ability to account for potential losses.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #2 of 12 Question ID: 439595

Assume that the value at risk (VAR) over a 1-day time horizon for an $80 million equity portfolio at the 95 percent
confidence level is calculated to be $792,000. Which of the following is a drawback to this VAR calculation?

✗ A) The measure is backward looking.

✗ B) The interpretation of the VAR measure would be different for a fixed-income portfolio.

✓ C) The actual loss in a time of extreme market stress could be much greater than $792,000.

✗ D) Increasing the time period used in the calculation will increase the VAR.

Explanation

One of the main drawbacks to VAR is that it fails to incorporate the loss that may occur beyond the 95% confidence
level, such as the loss that may occur with an extreme market event. This drawback of VAR is the reason stress
testing is necessary. Note that increasing the time period resulting in an increase in VAR would not be considered a
drawback; the fact that VAR is expressed in dollars means the interpretation would the same for a fixed-income
portfolio and that VAR is a forward-looking measure, not a backward-looking measure.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #3 of 12 Question ID: 439598

Stress testing is considered an intuitive risk management tool because:

✗ A) recent historical data greatly aids in the scenario selection.

✗ B) major structural shifts can be anticipated by business line managers.

✓ C) scenarios are drawn from factors that would likely impact portfolio value.
✗ D) correlation between underlying exposures is ignored.

Explanation

Stress testing has a strong intuitive appeal by identifying key scenarios without assigning specific probabilistic
statements about anticipated losses. Multidimensional stress testing includes correlation effects. Recent historical
data does not provide a complete enough history to identify extreme movements in key variables. Similarly,
anticipating structural shifts is very challenging.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #4 of 12 Question ID: 439597

Which of the following would NOT be considered stress testing?

✗ A) Exchange rate depreciation of 10% between $US relative to Japanese Yen.

✗ B) Yield curve twist of 50 basis points.

✗ C) Treasury yield curve shift of 100 basis points.

✓ D) S&P 500 index drop of 1%.

Explanation

Equity index falling 1% in one day is not unusual based upon historical data.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO
Question #5 of 12 Question ID: 439601

Which of the following is NOT a use of stress testing?

✗ A) It can highlight weaknesses in contingency planning and assumptions.

✗ B) It can be used for capital allocation across business units.

✗ C) Stress testing complements value at risk (VAR).

✓ D) It enables the risk manager to eliminate all risk from a portfolio.

Explanation

Stress testing cannot be used to eliminate all risk from a position. It only highlights the extent of losses in different states and
enables contingency planning, which is one of its benefits.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #6 of 12 Question ID: 439602

Which of the following is NOT a disadvantage of using stress testing? Stress testing:

✓ A) reflects only normal circumstances.

✗ B) fails to measure the by-products of major factor movements.

✗ C) fails to include the simultaneous adverse movements of risk factors.

✗ D) reflects the analyst's intentional and unintentional misspecification of the model.

Explanation

The primary purpose of stress testing is to model the effect of non-normal events that may not be reflected in the
typical VAR calculation. Thus it is unlikely that stress testing would only reflect normal events. Stress testing is
susceptible, however, to the analyst's intentional and unintentional misspecification of the model, the failure to
examine the by-products of major factor movements (how does a change in one factor affect the value of another),
and the failure to include the simultaneous adverse movements of risk factors.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO
Question #7 of 12 Question ID: 439600

Which of the following would least likely be a part of a stress test?

✗ A) Choosing the market factors.

✗ B) Choosing the time period over which the stress will take place.
✓ C) Computing market value at risk.

✗ D) Adjusting the correlations of risk factors.

Explanation

Computing market value at risk is not explicitly part of a stress test. The other possible answers are part of a stress
test along with choosing the amount of stress for each factor.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #8 of 12 Question ID: 439594

Which of the following statements best describes the uses of stress analysis?

✗ A) Scenario analysis can be used to model one-off hypothetical events but not actual events since
their probability of occurrence is very miniscule and, as they have already occurred, they are not
likely to recur.

✗ B) Scenario analysis, which is a special case of stress analysis, suffers from limitations on
implementing a consistent and manageable approach.

✗ C) Stress analysis has several advantages over a value at risk (VAR) only approach that includes:
highlighting inappropriate assumptions, hidden vulnerabilities, and the ability to be able to forecast
probability of rare but damaging events.

✓ D) Stress analysis can be used to enhance VAR analysis by focusing on the extent of loss in an
extreme event.

Explanation

This is the only valid use of stress analysis among the statements listed. Other statements either do not pertain to uses, even
if true in some other context, or are not true.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO
Question #9 of 12 Question ID: 439593

Which of the following most accurately describes the relationship between computing internal capital requirements using a
stress testing approach versus a value at risk (VAR) capital strength approach? Stress testing approaches:

✓ A) complement VAR approaches since they account for scenarios that may not be properly
considered in VAR approaches.

✗ B) should never be used since they are based entirely on subjective inputs.

✗ C) are substitutes for VAR approaches since they better measure the entire spectrum of potential
outcomes.

✗ D) can never be combined with VAR approaches because they are based on different probability
distributions.

Explanation

Since VAR often relies on common probability distributions, it may not properly capture extreme, but possible, events. Stress
testing involves evaluating the effects that these events would have on the institution and then establishing capital
requirement based on the findings. The two approaches are natural complements.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #10 of 12 Question ID: 439603

Which of the following is NOT a drawback to stress testing?

✓ A) It identifies important factors not observed in historical data.

✗ B) The number of scenarios increases greatly with additional risk factors.

✗ C) Historical correlations mix normal and hectic periods.

✗ D) Calculated losses may be extremely high relative to the 99% VAR significance level.

Explanation

Stress testing necessitates scenarios that have not appeared previously or do so very infrequently.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO
Question #11 of 12 Question ID: 439599

Stress testing is a non-statistical risk management tool because:

✗ A) non-parametric analysis is used.

✓ B) losses are computed based on anticipated movements in key variables without specific
probabilistic statements.

✗ C) it is objective in its determination of scenarios to evaluate.

✗ D) it specifies the minimum loss that will occur for a given significance level.

Explanation

Stress testing does not assign a probability to an expected loss but rather evaluates losses based on alternative
scenarios relevant to the firm's operations.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO

Question #12 of 12 Question ID: 439596

Which of the following is NOT an objective of stress testing? Simulate:

✗ A) temporary changes in key variables.

✗ B) permanent structural shifts.

✗ C) shocks that do not appear in historical data.

✓ D) shocks that are less likely to appear than historical evidence indicates.

Explanation

Stress testing analyzes events that are more likely to appear than suggested by historical data.

References

Question From: Topic Area 4 > Topic 68 > LO 1

Related Material:

Key Concepts by LO