Credit Risk Assessment Flashcards

Which formula correctly expresses expected loss (EL) on a credit exposure?

Answer: EL = PD × LGD × EAD

Expected loss is the product of probability of default, loss given default, and exposure at default.

A loan has a PD of 2%, an LGD of 40%, and an EAD of $1,000,000. What is the expected loss?

Answer: $8,000

0.02 × 0.40 × $1,000,000 = $8,000.

A commercial borrower reports a debt service coverage ratio (DSCR) of 0.90x. What does this indicate?

Answer: Operating cash flow is insufficient to fully cover scheduled debt service

A DSCR below 1.0x means available cash flow covers only 90% of required principal and interest.

Which of the five Cs of credit focuses primarily on a borrower's integrity and history of honoring obligations?

Answer: Character

Character assesses willingness to repay, reflected in reputation and repayment track record.

If the expected recovery rate on a defaulted secured loan is 65%, what is the loss given default?

Answer: 35%

LGD equals one minus the recovery rate, so 1 − 0.65 = 35%.

Which of the following is a qualitative rather than quantitative credit risk factor?

Answer: Depth and experience of the management team

Management quality is assessed through judgment rather than calculated from financial statements.

In counterparty credit risk, what is 'wrong-way risk'?

Answer: Risk that exposure to a counterparty rises as that counterparty's credit quality deteriorates

Wrong-way risk arises when exposure and default probability are positively correlated.