Credit Risk Management Practice Exam

What is the purpose of calculating stressed CVA?

1. To predict exact default rates across all markets

2. To apply real-time shocks and evaluate counterparty risk

3. To lower margin requirements for counterparties

4. To ensure uniform exposure across portfolios

The correct answer is: To apply real-time shocks and evaluate counterparty risk

Calculating stressed CVA (Credit Valuation Adjustment) is important because it involves applying real-time shocks to market factors in order to evaluate counterparty risk under adverse conditions. Stressed CVA is designed to reflect the potential changes in credit exposure and the corresponding impact on the valuation of derivatives when market conditions are unfavorable. This helps institutions better understand the risks they face due to counterparty defaults in stressed scenarios, offering a more robust assessment of credit risk. The process involves simulating scenarios that might result in heightened credit exposure, which is vital for effective risk management. It allows financial institutions to evaluate how likely it is that a counterparty may default when the market is experiencing stress, which is crucial for making informed decisions regarding risk mitigation and capital allocation. Recognizing this context, the other options either imply outcomes that are not the primary focus of stressed CVA calculation or pertain to broader concepts that do not specifically relate to evaluating counterparty risk under stress. For instance, predicting exact default rates is complex and varies widely, while lowering margin requirements is generally a separate risk management consideration. Ensuring uniform exposure across portfolios is also an important factor, but it does not directly address the specific purpose of stressed CVA calculations.