Credit Risk Management Trivia 2 — Questions and Answers
Question 1: Which U.S. legislation established minimum capital requirements for banks and was a precursor to Basel accords?
- Gramm-Leach-Bliley Act
- FDICIA of 1991 (Correct answer)
- Glass-Steagall Act
- Sarbanes-Oxley Act
Correct answer: FDICIA of 1991
The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 introduced prompt corrective action and risk-based capital standards for U.S. banks.
Question 2: In credit risk modeling, what does a Gini coefficient closer to 1.0 indicate about a scoring model?
- The model has poor discriminatory power
- The model perfectly separates good and bad borrowers (Correct answer)
- The model is overfitted to training data
- The model violates fair lending laws
Correct answer: The model perfectly separates good and bad borrowers
A Gini coefficient near 1.0 means the model nearly perfectly ranks borrowers by default risk, indicating excellent discriminatory power.
Question 3: What credit risk term describes the phenomenon where borrowers with higher credit limits tend to default at lower rates?
- Adverse selection (Correct answer)
- Line utilization paradox
- Behavioral scoring effect
- Credit limit anchoring
Correct answer: Adverse selection
Adverse selection occurs when higher-risk borrowers disproportionately seek and obtain credit, while lower-risk borrowers tend to use less of their available credit.
Question 4: Which rating agency introduced the concept of 'notching' for structured finance instruments?
- Moody's (Correct answer)
- Standard & Poor's
- Fitch Ratings
- DBRS Morningstar
Correct answer: Moody's
Moody's pioneered notching—adjusting ratings up or down relative to issuer ratings—to reflect structural features of specific debt instruments.
Question 5: What is the typical holding period assumed when calculating Value-at-Risk for a trading book under Basel market risk rules?
- 1 day
- 10 days (Correct answer)
- 30 days
- 90 days
Correct answer: 10 days
Basel market risk rules assume a 10-business-day holding period for VaR calculations in the trading book, reflecting the time needed to liquidate positions.
Question 6: In the context of credit derivatives, what is a 'cheapest-to-deliver' option?
- The right to choose which bond to deliver upon a credit event (Correct answer)
- A discount offered by protection sellers on CDS premiums
- The lowest-priced CDS contract in the market
- A clause allowing early termination of a credit default swap
Correct answer: The right to choose which bond to deliver upon a credit event
The cheapest-to-deliver option allows the protection buyer to deliver the least expensive eligible bond upon a credit event, giving them an advantage over the protection seller.
Question 7: Which financial metric measures the percentage of a defaulted loan that a lender recovers after accounting for collection costs?
- Exposure at Default
- Loss Given Default
- Probability of Default
- Recovery Rate (Correct answer)
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.
Credit Risk Management Trivia 2
Which U.S. legislation established minimum capital requirements for banks and was a precursor to Basel accords?