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FRM Part II Updated
How does the SREP aggregate risk and assign a supervisory score?
SREP is a holistic supervisory assessment across four blocks resulting in capital and liquidity decisions.
What does ILAAP cover and how does it differ from ICAAP?
ILAAP documents how banks identify, measure, and manage liquidity risk including intraday needs and stress scenarios.
How do threshold and MTA combine to affect collateralized exposure?
Threshold creates uncollateralized buffer; MTA delays small calls. For a $3M threshold, $500K MTA CSA with Orion Fairbank, residual peak PFE roughly equals threshold plus MTA plus MPR-diffusion — about $5.5M if diffusion is $2M.
How does collateral change the exposure profile of a trade?
Collateral with daily exchange compresses exposure dramatically, but the margin period of risk (10 days bilateral, 5 days cleared) sets a floor. For Cascadia, uncollateralized PFE of $48M drops to $9M with zero-threshold daily CSA.
What is ICAAP and how do banks run internal capital adequacy assessments?
ICAAP is the bank's own process for identifying, measuring, and managing all material risks with capital planning and stress testing.
How does Pillar 3 market discipline work and what disclosures are required?
Pillar 3 requires banks to publish standardized disclosures so markets can evaluate risk and discipline excessive risk-taking.
PFE vs EPE — what's the difference and when do I use each?
PFE is a high-percentile tail measure at a point in time used for credit limits. EPE is the time-average of EE used for regulatory capital (EAD = 1.4 x effective EPE). For Vanguard Helix, 97.5% PFE of $42M vs 1y EPE of $8M.
What percentile defines potential future exposure and how is it used for limits?
PFE is typically the 95% or 97.5% percentile; some banks use 99% for stress. For a 7y cross-currency swap with Nordhaven, 95% PFE of $28M, 97.5% of $34M, 99% of $42M. Set limits at netting-set level tiered by counterparty quality.
What is Pillar 2 supervisory review and how does it complement Pillar 1 minimums?
Pillar 2 is the supervisory review process addressing risks not fully captured in Pillar 1.
What does Pillar 1 of the Basel framework require for minimum regulatory capital?
Pillar 1 establishes minimum capital requirements as ratios of eligible capital to risk-weighted assets.
How do regime-dependent correlation models work?
Regime-dependent correlation models recognize that correlation parameters shift across market states, captured via DCC-GARCH, Markov-switching, or copula regime models...
How do I interpret and compute an expected exposure profile?
EE(t) is E[max(0, MTM(t))] averaged over Monte Carlo paths. For a 5y IRS with Kestrelbay, EE peaks mid-life. Interpret peak timing, compare to PFE for tail behavior, and recognize netting benefits typically cut EE 40-60%.
How do I describe the distribution of counterparty credit exposure over time?
Exposure distribution evolves as max(0, MTM) from surviving party's view. For a 10y IRS with Ironwood Capital, EE peaks around year 3-4 and declines. We summarize with EE (mean), PFE (high percentile), and EPE (time-average of EE).
What is the difference between upside and downside beta?
Upside and downside betas decompose total beta by sign of market return, capturing asymmetric systematic risk...
What is convexity risk in bank assets and how is it measured?
Convexity risk is the second-order sensitivity of asset value to interest rate changes.
How do banks backtest CVA models?
CVA backtesting is challenging because CVA is risk-neutral and forward-looking. Banks break backtesting into three components: exposure model backtesting (compare simulated EE to realized MtM), PD/credit spread backtesting, and CVA sensitivities backtesting via P&L attribution...
What should a Contingency Funding Plan contain?
A Contingency Funding Plan has governance, early warning indicators, funding options, scenario-action matrix, and testing. Activated when EWIs trigger.
What happens when a CMBS loan defaults at maturity — extension or modification?
CMBS special servicers extend, modify, DPO, or foreclose on defaulted loans. Senior investors favor quick resolution; subordinates favor extension. PSAs constrain servicer discretion.
What is lower partial moment and how is it used in risk measurement?
Lower partial moment of order n around threshold tau captures only downside deviations raised to power n...
How do we aggregate model risk across the enterprise?
Enterprise model risk aggregates through findings severity, tier distribution, limitation overrides, explicit reserves, and qualitative heat maps. No single scalar — structured combinations.
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