Credit Risk Management Credit Risk Modeling

Question 1

Which model uses a firm's asset value and volatility to estimate the probability of default?

Accepted Answer

Merton structural model

Answer

The Merton structural model treats equity as a call option on the firm's assets, deriving default probability from asset value and volatility.

Question 2

In the Altman Z-Score model, a score below 1.81 for a manufacturing firm typically indicates what?

Accepted Answer

High distress zone

Answer

Altman's original Z-Score places firms with a score below 1.81 in the 'distress zone,' indicating a high probability of bankruptcy.

Question 3

What does the term 'PD' stand for in credit risk modeling?

Accepted Answer

Probability of Default

Answer

PD (Probability of Default) is the likelihood that a borrower will fail to meet its debt obligations over a specified time horizon.

Question 4

In logistic regression credit scoring, what is the output variable range?

Accepted Answer

0 to 1

Answer

Logistic regression uses the sigmoid function to constrain output between 0 and 1, making it suitable for modeling default probabilities.

Question 5

Which of the following is a reduced-form credit risk model?

Accepted Answer

Jarrow-Turnbull model

Answer

The Jarrow-Turnbull model is a reduced-form model that treats default as a Poisson process with an intensity driven by market variables.

Credit Risk Management Practice Test