Module: | MODULE B: RISK MANAGEMENT
Q364: Scenario: The Risk Management Committee (RMC) instructs the Mid-Office to evaluate the potential impact on the bank's current equity portfolio if the stock market were to crash by 25% over three days, mirroring the exact price movements observed during the March 2020 global pandemic shock.
Based on standard stress testing taxonomy, which specific type of risk measurement methodology is the Mid-Office executing?
✅ Correct Answer: B
The correct answer is B. Stress testing evaluates portfolio resilience under extreme but plausible scenarios.
When a bank superimposes the exact market movements of a specific past crisis (such as the 2008 Lehman collapse, the 1997 Asian Financial Crisis, or the March 2020 COVID-19 crash) onto its *current* portfolio to calculate potential losses, it is strictly performing Historical Stress Testing.
Option A is incorrect because Hypothetical Stress Testing involves inventing completely new, "what-if" scenarios that have not historically occurred.
Option C is incorrect as Parametric VaR is for normal market conditions, not extreme stress.
Option D is incorrect; Reverse Stress Testing works backward by defining a catastrophic loss (e.g., bankruptcy) and then discovering what scenarios could cause it.
When a bank superimposes the exact market movements of a specific past crisis (such as the 2008 Lehman collapse, the 1997 Asian Financial Crisis, or the March 2020 COVID-19 crash) onto its *current* portfolio to calculate potential losses, it is strictly performing Historical Stress Testing.
Option A is incorrect because Hypothetical Stress Testing involves inventing completely new, "what-if" scenarios that have not historically occurred.
Option C is incorrect as Parametric VaR is for normal market conditions, not extreme stress.
Option D is incorrect; Reverse Stress Testing works backward by defining a catastrophic loss (e.g., bankruptcy) and then discovering what scenarios could cause it.