Credit Risk Management Credit Risk Modeling 2 — Questions and Answers
Question 1: Loss Given Default (LGD) is defined as what percentage?
- The probability a borrower defaults
- The outstanding balance at default
- The portion of exposure lost when a default occurs (Correct answer)
- The recovery rate on a loan
Correct answer: The portion of exposure lost when a default occurs
LGD represents the proportion of exposure that is not recovered after a default event, expressed as a percentage of EAD.
Question 2: What does EAD stand for in credit risk?
- Expected Annual Default
- Exposure at Default (Correct answer)
- Earnings After Depreciation
- External Asset Duration
Correct answer: Exposure at Default
Exposure at Default (EAD) is the estimated loan balance outstanding at the time a borrower defaults.
Question 3: Expected Loss (EL) is correctly calculated as which of the following?
- PD × LGD
- PD × EAD
- PD × LGD × EAD (Correct answer)
- LGD × EAD
Correct answer: PD × LGD × EAD
Expected Loss equals the product of Probability of Default, Loss Given Default, and Exposure at Default.
Question 4: Which statistical technique is commonly used to build retail credit scorecards?
- Monte Carlo simulation
- Logistic regression (Correct answer)
- Principal component analysis
- Cointegration analysis
Correct answer: Logistic regression
Logistic regression is the industry-standard technique for retail credit scorecards due to its interpretability and probabilistic output.
Question 5: In credit risk modeling, what is 'vintage analysis' used for?
- Measuring recovery rates on defaulted loans
- Tracking default performance of loan cohorts originated at the same time (Correct answer)
- Estimating market risk of a bond portfolio
- Calculating credit conversion factors
Correct answer: Tracking default performance of loan cohorts originated at the same time
Vintage analysis groups loans by their origination period and tracks performance over time to identify underwriting quality trends.
Question 6: What is the purpose of a 'stress test' in credit risk modeling?
- To validate scorecard Gini coefficients
- To evaluate portfolio losses under severe but plausible adverse scenarios (Correct answer)
- To measure day-to-day market value changes
- To calculate expected loss under base-case assumptions
Correct answer: To evaluate portfolio losses under severe but plausible adverse scenarios
Stress testing assesses how credit losses would increase under severe economic downturns, informing capital planning and risk appetite.
Credit Risk Management Credit Risk Modeling 2
Loss Given Default (LGD) is defined as what percentage?