Credit Risk Management Trivia 4

Question 1

What is 'wrong-way risk' in the context of credit derivatives and counterparty credit risk?

Accepted Answer

Risk that the counterparty defaults at the worst possible time when exposure is highest

Answer

Wrong-way risk occurs when exposure to a counterparty is positively correlated with the counterparty's default risk, so the exposure is highest precisely when default is most likely.

Question 2

Which U.S. regulatory framework requires banks to conduct annual stress tests to assess capital adequacy?

Accepted Answer

Dodd-Frank Act (DFAST)

Answer

The Dodd-Frank Act Stress Testing (DFAST) framework requires U.S. banks with over $100 billion in assets to conduct annual stress tests and report results publicly.

Question 3

What does a 'negative pledge clause' in a loan agreement protect against?

Accepted Answer

Borrower pledging assets as collateral to other lenders

Answer

A negative pledge clause prevents the borrower from granting security interests to other creditors, protecting existing lenders' unsecured position from being subordinated.

Question 4

In structured credit, what is a 'waterfall' payment structure?

Accepted Answer

The priority order in which cash flows are distributed to different tranches

Answer

A waterfall defines the sequential priority by which principal and interest payments are distributed to different tranches, with senior tranches paid before subordinate ones.

Question 5

Which credit risk measure represents the average loss in the worst percentage of scenarios beyond the VaR threshold?

Accepted Answer

Conditional VaR (CVaR)

Answer

Conditional VaR (CVaR), also called Expected Shortfall, measures the average loss in scenarios that exceed the VaR threshold, capturing tail risk more comprehensively than VaR alone.

Credit Risk Management Practice Test

Credit Risk Management Practice Test

Credit Risk Management Trivia 4