AIM 1: Discuss how stress testing complements VAR.

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

A) losses are computed based on anticipated movements in key variables without specific probabilistic statements. 
 
B) non-parametric analysis is used. 
 
C) it specifies the minimum loss that will occur for a given significance level. 
 
D) it is objective in its determination of scenarios to evaluate. 

The  correct answer is A

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.

2、Stress testing is considered an intuitive risk management tool because:

A) recent historical data greatly aids in the scenario selection. 
 
B) scenarios are drawn from factors that would likely impact portfolio value. 
 
C) correlation between underlying exposures is ignored. 
 
D) major structural shifts can be anticipated by business line managers. 

The  correct answer is B

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.

3、Which of the following would NOT be considered stress testing?

A) S& 500 index drop of 1%.
 
B) Yield curve twist of 50 basis points. 
 
C) Exchange rate depreciation of 10% between $US relative to Japanese Yen. 
 
D) Treasury yield curve shift of 100 basis points. 

The  correct answer is A

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

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

A) shocks that do not appear in historical data.
 
B) permanent structural shifts. 
 
C) temporary changes in key variables. 
 
D) shocks that are less likely to appear than historical evidence indicates. 
 

The  correct answer is D

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