Credit Risk Management Credit Risk Management MCQ 2 — Questions and Answers
Question 1: Which Basel III metric requires banks to maintain a minimum ratio of high-quality liquid assets to net cash outflows over a 30-day stress period?
- Net Stable Funding Ratio (NSFR)
- Liquidity Coverage Ratio (LCR) (Correct answer)
- Leverage Ratio
- Capital Conservation Buffer
Correct answer: Liquidity Coverage Ratio (LCR)
The Liquidity Coverage Ratio (LCR) requires banks to hold enough high-quality liquid assets to survive a 30-day stress scenario.
Question 2: A bank's loan portfolio has an expected loss of $2M and unexpected loss of $8M. What is the total economic capital needed if the bank uses a confidence level that covers both?
- $2M
- $8M
- $10M (Correct answer)
- $6M
Correct answer: $10M
Economic capital covers both expected and unexpected losses, so the total is $2M + $8M = $10M.
Question 3: In credit risk modeling, what does a 'through-the-cycle' (TTC) rating approach primarily aim to achieve?
- Reflect current macroeconomic conditions
- Remain stable across economic cycles by capturing long-run average risk (Correct answer)
- Maximize short-term profitability
- Comply with mark-to-market accounting rules
Correct answer: Remain stable across economic cycles by capturing long-run average risk
TTC ratings aim to be stable across the business cycle by reflecting long-run average credit quality rather than current conditions.
Question 4: Which concentration risk measure captures the additional risk from having large exposures to a single counterparty or sector?
- Herfindahl-Hirschman Index (HHI) (Correct answer)
- Value-at-Risk (VaR)
- Sharpe Ratio
- Default Correlation
Correct answer: Herfindahl-Hirschman Index (HHI)
The Herfindahl-Hirschman Index quantifies concentration by summing squared market shares or exposure fractions.
Question 5: Under the IRB approach, which parameter directly captures the percentage of exposure a bank expects to lose given a default has occurred?
- Probability of Default (PD)
- Exposure at Default (EAD)
- Loss Given Default (LGD) (Correct answer)
- Maturity (M)
Correct answer: Loss Given Default (LGD)
Loss Given Default (LGD) represents the fraction of EAD that the bank expects to lose after recoveries when a borrower defaults.
Question 6: A credit default swap (CDS) spread widens significantly for a corporate issuer. What does this most directly indicate?
- Decreased market liquidity for the issuer's bonds
- Increased perceived credit risk of the issuer (Correct answer)
- Improved creditworthiness of the issuer
- Lower interest rate environment
Correct answer: Increased perceived credit risk of the issuer
A widening CDS spread reflects the market's increased perception of default risk for the reference entity.
Question 7: In the Merton structural model of credit risk, default occurs when:
- The firm's stock price drops below the risk-free rate
- The firm's asset value falls below the face value of its debt at maturity (Correct answer)
- The firm misses a coupon payment
- The firm's credit rating is downgraded below investment grade
Correct answer: The firm's asset value falls below the face value of its debt at maturity
Merton's model treats equity as a call option on assets; default occurs when assets fall below the debt face value at maturity.
Credit Risk Management Credit Risk Management MCQ 2
Which Basel III metric requires banks to maintain a minimum ratio of high-quality liquid assets to net cash outflows over a 30-day stress period?