PRMIA Credit and Counterparty Risk Manager (CCRM) Certificate — Questions and Answers

Question 1: What is the 'recovery rate paradox' in credit risk?

Secured loans recover less than unsecured loans
Higher quality borrowers have higher LGD than lower quality borrowers
Recovery rates tend to be lower in downturns precisely when default rates are highest (Correct answer)
LGD increases as maturity extends

Correct answer: Recovery rates tend to be lower in downturns precisely when default rates are highest

The recovery rate paradox refers to the empirical finding that recoveries fall during economic downturns when defaults peak, creating a 'double hit' that is worse than assuming independence.

Question 2: Which tranche of a CDO is the first to absorb credit losses?

Mezzanine tranche
Equity (first loss) tranche (Correct answer)
Super senior tranche
Senior tranche

Correct answer: Equity (first loss) tranche

The equity or first-loss tranche absorbs the first losses in the CDO pool, protecting more senior tranches; in return, it receives the highest yield.

Question 3: Which regulatory concept requires banks to hold additional capital above minimums based on their systemic importance to the financial system?

Capital conservation buffer
Pillar 2 add-on
G-SIB surcharge (Correct answer)
Countercyclical capital buffer

Correct answer: G-SIB surcharge

The Global Systemically Important Bank (G-SIB) surcharge requires the largest, most interconnected banks to hold 1-3.5% additional CET1 capital above Basel III minimums due to their systemic risk.

Question 4: Under the advanced IRB approach, which of the following parameters must banks estimate internally rather than using supervisory estimates?

PD only
PD, LGD, and EAD (Correct answer)
PD and LGD only
Only EAD

Correct answer: PD, LGD, and EAD

Under the Advanced IRB approach, banks provide their own internal estimates for PD, LGD, and EAD, subject to supervisory validation.

Question 5: Which regulatory framework introduced the mandatory clearing and margining requirements for standardized OTC derivatives in the United States?

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) (Correct answer)
Sarbanes-Oxley Act (2002)
Gramm-Leach-Bliley Act (1999)
Bank Secrecy Act (1970)

Correct answer: Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

Title VII of the Dodd-Frank Act introduced mandatory central clearing, exchange trading, and margin requirements for standardized OTC derivatives to reduce systemic counterparty credit risk.

Question 6: Which validation metric measures the area under the Receiver Operating Characteristic (ROC) curve?

Kolmogorov-Smirnov (KS) statistic
Gini coefficient
F1 score
AUROC (AUC) (Correct answer)

Correct answer: AUROC (AUC)

AUROC (Area Under the ROC Curve) measures overall discriminatory power of a credit model across all possible classification thresholds.

Question 7: What is Risk-Adjusted Return on Capital (RAROC) used for in portfolio management?

Comparing risk-adjusted profitability across business lines or deals (Correct answer)
Estimating the probability of default on a loan
Calculating regulatory minimum capital
Measuring interest rate sensitivity

Correct answer: Comparing risk-adjusted profitability across business lines or deals

RAROC divides risk-adjusted return by economic capital, enabling banks to compare profitability on a like-for-like basis across different risk levels.

Question 8: What is a 'credit-linked note' (CLN)?

A funded credit instrument that embeds a CDS, where the investor's principal is at risk if a credit event occurs (Correct answer)
A convertible bond with a credit enhancement feature
A government bond with a floating-rate coupon
A note whose coupon is linked to the issuer's own credit rating

Correct answer: A funded credit instrument that embeds a CDS, where the investor's principal is at risk if a credit event occurs

A CLN is a funded version of a CDS: the investor provides upfront cash, earns an enhanced coupon, but loses some or all principal if the reference entity experiences a credit event.

Question 9: What does EAD stand for in credit risk?

Earnings After Depreciation
External Asset Duration
Expected Annual Default
Exposure at Default (Correct answer)

Correct answer: Exposure at Default

Exposure at Default (EAD) is the estimated loan balance outstanding at the time a borrower defaults.

Question 10: Which financial metric measures the percentage of a defaulted loan that a lender recovers after accounting for collection costs?

Loss Given Default
Exposure at Default
Recovery Rate (Correct answer)
Probability of Default

Correct answer: Recovery Rate

Recovery rate is the percentage of a defaulted loan's value that is ultimately recovered by the lender, net of collection and legal costs.

Question 11: What does the CDS spread represent?

The credit rating difference between two reference entities
The annual premium (in basis points) paid by the protection buyer as a percentage of notional (Correct answer)
The difference between bid and ask prices for the reference bond
The discount rate used to value the reference bond

Correct answer: The annual premium (in basis points) paid by the protection buyer as a percentage of notional

The CDS spread is the annualized cost of credit protection, expressed in basis points of notional; it reflects the market's implied probability of a credit event.

Question 12: What is the 'time to recovery' or 'resolution period' concept in default analysis?

The time elapsed between a default event and the final resolution or recovery of the debt (Correct answer)
The average age of loans at time of default
The number of months before a loan is written off
The time from application to loan origination

Correct answer: The time elapsed between a default event and the final resolution or recovery of the debt

Resolution period measures how long it takes from default until recovery is finalized; longer resolution periods reduce the present value of recovered amounts.

Question 13: A Credit Valuation Adjustment (CVA) desk at a bank primarily manages risk by:

Approving new counterparty credit limits for derivative transactions
Hedging the CVA P&L volatility using CDS, index options, and swaptions (Correct answer)
Conducting internal stress tests of the bank's liquidity buffers
Setting loan loss provisions for the corporate lending portfolio

Correct answer: Hedging the CVA P&L volatility using CDS, index options, and swaptions

The CVA desk dynamically hedges the CVA P&L using credit default swaps on individual counterparties, CDS indices, and interest rate or cross-currency hedges to neutralize market and credit sensitivity.

Question 14: What is the minimum Tier 1 capital ratio required under Basel III?

4.5%
6% (Correct answer)
8%
2%

Correct answer: 6%

Basel III requires a minimum Tier 1 capital ratio of 6% of risk-weighted assets, strengthening capital quality requirements from Basel II.

Question 15: Which regulatory framework introduced the Internal Ratings-Based (IRB) approach for calculating credit risk capital requirements?

Dodd-Frank Act
Sarbanes-Oxley Act
Basel I
Basel II (Correct answer)

Correct answer: Basel II

Basel II introduced the IRB approach, allowing banks to use internal models to estimate PD, LGD, and EAD for capital calculations.

Question 16: Under a standard ISDA Master Agreement, netting reduces counterparty credit risk by:

Capping the maximum exposure at the notional amount
Requiring additional collateral posting when exposure exceeds a threshold
Transferring credit risk to a central counterparty
Allowing positive and negative mark-to-market values across transactions to offset each other (Correct answer)

Correct answer: Allowing positive and negative mark-to-market values across transactions to offset each other

Close-out netting under an ISDA agreement allows offsetting of gains and losses across all transactions with a counterparty upon default, reducing gross exposure to a net figure.

Question 17: What is the 'Gaussian copula' model and why is it controversial?

A correlation model for pricing CDO tranches, criticized for underestimating tail dependence (Correct answer)
A credit scoring model rejected by regulators for racial bias
An early VaR model banned by Basel II
An interest rate model used for mortgage pricing, criticized for ignoring default risk

Correct answer: A correlation model for pricing CDO tranches, criticized for underestimating tail dependence

The Gaussian copula was widely used to price CDOs by modeling correlated defaults; it was criticized post-2008 for underestimating the probability of simultaneous mass defaults.

Question 18: What does 'mark-to-market' mean in the context of a CDS position?

Accounting for CDS only at maturity or credit event
Settling all payments at the original contracted spread
Recording the CDS at the notional principal amount
Valuing the CDS at current fair value based on prevailing market spreads (Correct answer)

Correct answer: Valuing the CDS at current fair value based on prevailing market spreads

Mark-to-market (MtM) values a CDS position daily based on current market CDS spreads, reflecting changes in the reference entity's credit quality.

Question 19: What is the 'through-the-cycle' (TTC) approach to PD estimation?

PD based only on current market conditions
PD estimates that vary with each economic cycle phase
PD derived from equity market prices
PD estimates averaged across an entire economic cycle (Correct answer)

Correct answer: PD estimates averaged across an entire economic cycle

TTC PD estimates reflect long-run average default rates across full economic cycles, reducing procyclicality in capital requirements.

Question 20: In the context of credit risk, 'exposure at default' (EAD) for an undrawn revolving credit facility is most significantly affected by:

The maturity of the revolving facility
The collateral type posted by the borrower
The credit conversion factor (CCF) applied to the undrawn commitment (Correct answer)
The borrower's current leverage ratio

Correct answer: The credit conversion factor (CCF) applied to the undrawn commitment

The CCF estimates how much of the undrawn commitment a borrower is likely to draw before defaulting, directly determining EAD.

Question 21: Which covenant type in a leveraged loan agreement requires the borrower to maintain a minimum financial ratio throughout the life of the loan?

Maintenance covenant (Correct answer)
Negative pledge covenant
Incurrence covenant
Cross-default covenant

Correct answer: Maintenance covenant

Maintenance covenants require borrowers to meet financial ratio tests (e.g., minimum DSCR) on a regular testing basis, providing lenders with early warning of deterioration.

Question 22: What is 'credit spread risk' in a fixed income portfolio?

The risk of prepayment on mortgage-backed securities
The risk that a bond's coupon is insufficient to cover funding costs
The risk that the yield spread of a credit instrument over the risk-free rate widens, causing a mark-to-market loss (Correct answer)
The risk of rating agency downgrades reducing bond prices

Correct answer: The risk that the yield spread of a credit instrument over the risk-free rate widens, causing a mark-to-market loss

Credit spread risk is the sensitivity of bond or derivative prices to changes in the credit spread; wider spreads cause bond prices to fall, generating mark-to-market losses.

Question 23: What is 'sector concentration risk' in credit portfolio management?

Geographic clustering of retail mortgage borrowers
Excessive portfolio exposure to one industry, making it vulnerable to sector-wide downturns (Correct answer)
Concentration of short-dated loans in one maturity bucket
Overexposure to high-yield bonds within a single sector

Correct answer: Excessive portfolio exposure to one industry, making it vulnerable to sector-wide downturns

Sector concentration risk arises when too large a portion of the portfolio is in one industry; a sector downturn can cause correlated defaults across many borrowers.

Question 24: Which statistical model estimates the probability of default by regressing binary default outcomes against borrower characteristics?

Principal component analysis
Moving average model
Logistic regression (Correct answer)
Linear regression

Correct answer: Logistic regression

Logistic regression models the probability of a binary outcome (default/non-default) as a function of borrower financial variables.

Question 25: What is 'tail risk' in the context of credit portfolio management?

Credit risk from derivatives with small notional values
Risk from short-maturity loans at the end of their life
Risk of extreme losses in the tail of the loss distribution, beyond expected and typical outcomes (Correct answer)
The risk of prepayment on mortgage portfolios

Correct answer: Risk of extreme losses in the tail of the loss distribution, beyond expected and typical outcomes

Tail risk refers to the probability and magnitude of extreme portfolio losses in the far tail of the distribution, often triggered by systemic events.

Question 26: Credit Value Adjustment (CVA) is best described as:

The loss given default on a secured loan
The spread charged on a corporate bond above the risk-free rate
The market value of counterparty credit risk embedded in a derivatives portfolio (Correct answer)
The regulatory capital charge under Basel III for market risk

Correct answer: The market value of counterparty credit risk embedded in a derivatives portfolio

CVA represents the difference between the risk-free portfolio value and the true portfolio value accounting for the possibility of counterparty default.

Question 27: Which of the following best describes the 'jump-to-default' risk in a Credit Default Swap (CDS) from the protection seller's perspective?

The risk of an immediate large loss if the reference entity defaults before the CDS can be hedged (Correct answer)
The risk that the protection buyer fails to pay periodic premiums
The risk that the notional amount of the CDS exceeds the outstanding debt of the reference entity
The risk that the CDS spread widens before the position can be unwound

Correct answer: The risk of an immediate large loss if the reference entity defaults before the CDS can be hedged

Jump-to-default risk is the risk that the reference entity defaults suddenly without warning, causing the protection seller to pay out the full notional minus recovery before any hedging can be done.

Question 28: Under EMIR (European Market Infrastructure Regulation), which types of OTC derivatives are subject to mandatory central clearing?

Commodity derivatives traded on regulated exchanges
Only foreign exchange spot transactions between banks
Standardized OTC derivatives between financial counterparties above a clearing threshold (Correct answer)
All OTC derivatives regardless of standardization or counterparty type

Correct answer: Standardized OTC derivatives between financial counterparties above a clearing threshold

EMIR mandates central clearing for standardized OTC derivatives (e.g., plain vanilla interest rate swaps and CDS indices) when counterparties exceed specified clearing thresholds.

Question 29: In stress testing a credit portfolio, what is the primary objective of a 'reverse stress test'?

To maximize regulatory capital relief
To work backwards from a predefined failure outcome to find scenarios that could cause it (Correct answer)
To test the portfolio under average economic conditions
To identify the worst historical loss scenario

Correct answer: To work backwards from a predefined failure outcome to find scenarios that could cause it

Reverse stress testing starts with a catastrophic outcome (e.g., insolvency) and identifies what scenarios could plausibly cause it.

Question 30: Expected Loss (EL) is correctly calculated as which of the following?

PD × LGD × EAD (Correct answer)
PD × LGD
PD × EAD
LGD × EAD

Correct answer: PD × LGD × EAD

Expected Loss equals the product of Probability of Default, Loss Given Default, and Exposure at Default.

PRMIA Credit and Counterparty Risk Manager (CCRM) Certificate

The PRMIA CCRM Certificate assesses mastery of credit risk fundamentals, counterparty credit risk, CVA/DVA, credit derivatives, credit portfolio management, and Basel regulatory frameworks for financial risk professionals.

Questions

35 min

Time Limit

60%

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