Credit Risk Management Credit Risk Management MCQ 4 — Questions and Answers
Question 1: Under IFRS 9, which stage classification applies to financial assets that have experienced a significant increase in credit risk since origination but have not yet defaulted?
- Stage 1
- Stage 2 (Correct answer)
- Stage 3
- Stage 4
Correct answer: Stage 2
Stage 2 under IFRS 9 applies to assets with a significant increase in credit risk, requiring lifetime expected credit loss provisioning.
Question 2: A borrower's Debt Service Coverage Ratio (DSCR) is 0.85. What does this indicate for a lender?
- The borrower generates 85% more cash flow than needed to service debt
- The borrower cannot cover debt service from operating cash flows, increasing default risk (Correct answer)
- The borrower has strong liquidity reserves
- The borrower's assets exceed liabilities by 85%
Correct answer: The borrower cannot cover debt service from operating cash flows, increasing default risk
A DSCR below 1.0 means operating income is insufficient to cover debt payments, signaling elevated credit risk.
Question 3: Which statistical model estimates the probability of default by regressing binary default outcomes against borrower characteristics?
- Linear regression
- Logistic regression (Correct answer)
- Moving average model
- Principal component analysis
Correct answer: Logistic regression
Logistic regression models the probability of a binary outcome (default/non-default) as a function of borrower financial variables.
Question 4: In a collateralized lending arrangement, 'haircut' refers to:
- The fee charged by the custodian for holding collateral
- The percentage reduction applied to the market value of collateral to determine its lending value (Correct answer)
- The interest rate spread above LIBOR charged on secured loans
- The maximum loan-to-value ratio allowed by regulation
Correct answer: The percentage reduction applied to the market value of collateral to determine its lending value
A haircut reduces the accepted value of collateral below its market value to buffer against price volatility and forced-sale risk.
Question 5: What is the key distinction between 'incurred loss' (IAS 39) and 'expected loss' (IFRS 9) provisioning models?
- Incurred loss provisions are larger than expected loss provisions
- Expected loss provisions are recognized earlier — at origination — rather than waiting for a loss event to occur (Correct answer)
- Expected loss provisioning applies only to sovereign exposures
- Incurred loss models require more frequent credit reviews
Correct answer: Expected loss provisions are recognized earlier — at origination — rather than waiting for a loss event to occur
IFRS 9's expected loss model requires banks to provision for credit losses from day one, whereas IAS 39 required a triggering loss event first.
Question 6: A bank holds a $10M loan exposure with a 40% LGD. If the borrower defaults, what is the expected loss assuming a 5% PD?
- $200,000 (Correct answer)
- $400,000
- $2,000,000
- $500,000
Correct answer: $200,000
Expected Loss = PD × LGD × EAD = 5% × 40% × $10M = $200,000.
Question 7: Which credit risk transfer mechanism allows a bank to buy protection on a basket of reference entities, where the protection seller pays out only on the first default in the basket?
- Total Return Swap
- First-to-Default Basket CDS (Correct answer)
- Synthetic CDO equity tranche
- Credit-Linked Note
Correct answer: First-to-Default Basket CDS
A first-to-default basket CDS triggers a payout upon the first default among the reference entities in the basket, giving concentrated protection at lower cost.
Credit Risk Management Credit Risk Management MCQ 4
Under IFRS 9, which stage classification applies to financial assets that have experienced a significant increase in credit risk since origination but have not yet defaulted?