The short version is that anything that would cause significant immediate stress gives you a Threat Level. When you have more Threat Levels than CUF, you start taking penalties. At -5, your character shuts down.
One of the coolest tips in the book, by the way, is the use of Threat Tokens to help players keep track. The two best examples are spent casings and candy. No eating until combat ends or you reduce your TLs! D:
So how does this affect our characters? Let's take a look!
Some threats are basic. For example, combat occurring is always 1 TL. It's just plain stressful. Ding!
Neither of our PCs have been attacked directly, but the enemy is using burst fire. Ding!
Moving along to some tactical considerations, our PCs are being ambushed (Ding!), fighting in darkness (Ding!).
Our PCs can see the enemy, though and what you don't know about can't hurt you--since the ones they can't see haven't attacked or made themselves known in any way, no threat levels from that.
Bob states that Donkey getting ripped up counts as a friendly casualty for him, adding another TL to Bob.
So Smythe has 4 TLs, Bob has 5. Now let's look at what mitigates them. These results temporarily raise your CUF. That's slightly different than lowering TLs, because you may need to make a CUF check... and these things provide a certain boost to confidence under duress.
So far they only benefit from Tango Down: Smythe can say with confidence that she has dealt with the machinegunner. +1 CUF (maximum bonus from this: +3)
Smythe has CUF 7, raised to 8 from that alone. She has taken 4 TLs, so suffers no penalties yet.
Bob on the other hand has a CUF of 3 which, while not terrible, isn't going to do his underpants any favours. Bob has 5 TLs, which is 2 more than his CUF... so all of Bob's actions take a -2 penalty.
On the other point, for roleplaying his character well the GM awards Bob a Survival Point. After all, he didn't have to count Donkey as a pet.
Something else to note: If Bob is attacked (Ding!) with lethal force (Ding!) by someone he can't see (Ding!), he'll be at -5 and no longer able to carry the fight.
Now might be a good time for Bob to dig into his 20kg of "Personal Gear" and decide he had some night-vision goggles!