Credit Risk Management Default and Recovery Analysis 1 — Questions and Answers
Question 1: Under Basel, the standard definition of default requires a borrower to be past due how many days?
- 30 days
- 60 days
- 90 days (Correct answer)
- 120 days
Correct answer: 90 days
Basel defines default as occurring when a borrower is 90 days past due on a material obligation or when the bank believes full repayment is unlikely.
Question 2: What is the 'recovery rate' on a defaulted loan?
- The amount drawn at the time of default
- The fraction of the defaulted exposure that is ultimately recovered (Correct answer)
- The number of days a loan is past due
- The interest rate charged on the loan before default
Correct answer: The fraction of the defaulted exposure that is ultimately recovered
Recovery rate is the proportion of exposure at default (EAD) recovered after a default event, often measured as a percentage.
Question 3: Which factor most strongly affects Loss Given Default (LGD) on a secured loan?
- The borrower's credit score
- The quality and value of the collateral (Correct answer)
- The loan's original maturity
- The benchmark interest rate at origination
Correct answer: The quality and value of the collateral
Collateral quality and value are the primary determinants of LGD for secured loans; higher-quality collateral reduces potential losses upon default.
Question 4: What does 'seniority' of a debt claim refer to in the context of recovery?
- The age of the loan in years
- The priority of repayment in the event of bankruptcy or liquidation (Correct answer)
- The credit rating of the issuer
- The currency denomination of the debt
Correct answer: The priority of repayment in the event of bankruptcy or liquidation
Seniority determines the order in which creditors are repaid; senior secured creditors are paid first, followed by senior unsecured, subordinated, and equity holders.
Question 5: What is 'cure rate' in credit risk management?
- The proportion of defaulted loans that return to performing status (Correct answer)
- The percentage of loans that never enter delinquency
- The speed at which collections recover defaulted amounts
- The rate at which credit scores improve post-default
Correct answer: The proportion of defaulted loans that return to performing status
The cure rate measures the proportion of defaulted or delinquent accounts that subsequently return to fully performing status without formal restructuring.
Question 6: In a bankruptcy process under US Chapter 7, what happens to the debtor's assets?
- Assets are protected while the debtor reorganizes its business
- Assets are liquidated and proceeds distributed to creditors in priority order (Correct answer)
- Assets are transferred to the government
- Assets are auctioned to management at a discount
Correct answer: Assets are liquidated and proceeds distributed to creditors in priority order
Chapter 7 bankruptcy involves liquidating the debtor's non-exempt assets and distributing proceeds to creditors according to the absolute priority rule.
Credit Risk Management Default and Recovery Analysis 1
Under Basel, the standard definition of default requires a borrower to be past due how many days?