Banking Exam Credit Risk and Analysis 3 — Questions and Answers
Question 1: A commercial real estate loan has an LTV of 85%. Which best describes the lender's risk position?
- Low risk because the property covers most of the loan
- Elevated risk with limited equity cushion if property values decline (Correct answer)
- No risk because real estate always appreciates
- Zero risk due to government guarantees
Correct answer: Elevated risk with limited equity cushion if property values decline
An 85% LTV leaves only 15% equity cushion, meaning even a modest property value decline could result in the loan being underwater.
Question 2: What is 'loss given default' (LGD) in credit risk?
- The probability that a borrower will default
- The portion of exposure a lender loses after recoveries when a borrower defaults (Correct answer)
- The total outstanding balance at default
- The regulatory capital charge for a defaulted loan
Correct answer: The portion of exposure a lender loses after recoveries when a borrower defaults
LGD measures what percentage of EAD is actually lost after collateral liquidation and recovery efforts following a default event.
Question 3: Which type of credit risk analysis focuses on industry trends, competitive position, and macroeconomic factors?
- Quantitative analysis
- Qualitative analysis (Correct answer)
- Behavioral scoring
- Stress testing
Correct answer: Qualitative analysis
Qualitative analysis evaluates non-numeric factors like management quality, industry dynamics, and competitive advantages that affect repayment capacity.
Question 4: A bank uses a 'through-the-cycle' (TTC) approach to PD estimation. What does this mean?
- PD is recalculated daily based on market prices
- PD reflects average default rates across the full economic cycle, not just current conditions (Correct answer)
- PD is set at the peak default rate observed historically
- PD is fixed at origination and never updated
Correct answer: PD reflects average default rates across the full economic cycle, not just current conditions
TTC PD estimates are stable across economic cycles, reducing procyclicality compared to point-in-time (PIT) estimates.
Question 5: Under the 5 Cs of credit, 'capacity' refers to:
- The collateral pledged to secure the loan
- The borrower's cash flow and ability to repay the debt (Correct answer)
- The borrower's character and credit history
- Economic and market conditions affecting repayment
Correct answer: The borrower's cash flow and ability to repay the debt
Capacity assesses whether the borrower generates sufficient income or cash flow to meet debt obligations.
Question 6: Which credit risk metric measures the total amount a borrower owes at the time of default?
- Probability of Default (PD)
- Loss Given Default (LGD)
- Exposure at Default (EAD) (Correct answer)
- Expected Loss (EL)
Correct answer: Exposure at Default (EAD)
EAD is the outstanding balance plus accrued interest and undrawn commitments the lender is exposed to at the moment of default.
Question 7: A bank's internal credit rating system downgrades a borrower from 'pass' to 'special mention.' This typically indicates:
- The loan is in default and charge-off is imminent
- Potential weaknesses that deserve management attention but do not yet threaten repayment (Correct answer)
- The borrower has filed for bankruptcy
- The loan has been fully paid off
Correct answer: Potential weaknesses that deserve management attention but do not yet threaten repayment
Special mention is a regulatory classification for loans with potential weaknesses requiring close monitoring but not yet classified as substandard.
Banking Exam Credit Risk and Analysis 3
A commercial real estate loan has an LTV of 85%.
Which best describes the lender's risk position?