Financial Risk Management Credit Risk Analysis 2

Question 1

What is a 'credit rating migration matrix' used for in credit risk?

Accepted Answer

Quantifying the probability of a borrower moving from one credit rating to another over a given period

Answer

Estimating recovery rates on defaulted bonds

Answer

Measuring the market risk of a bond portfolio

Answer

Calculating the duration of a fixed income instrument

Question 2

What is 'credit spread' in fixed income markets?

Accepted Answer

The yield difference between a corporate (or risky) bond and a risk-free government bond of the same maturity

Answer

The difference between a bond's coupon rate and its face value yield

Answer

The bid-ask spread on corporate bond trades

Answer

The difference between spot and forward credit default swap premiums

Question 3

What is 'default correlation' and why does it matter for credit portfolios?

Accepted Answer

The tendency of multiple borrowers to default at the same time, which affects portfolio credit losses during economic downturns

Answer

The correlation between a bond's credit spread and its duration

Answer

The relationship between PD and LGD for individual borrowers

Answer

The correlation between credit ratings assigned by different agencies

Question 4

What is the Z-score model (Altman) primarily used for?

Accepted Answer

Predicting the probability of corporate bankruptcy using financial ratios

Answer

Measuring interest rate risk of a bond portfolio

Answer

Estimating recovery rates in leveraged buyouts

Answer

Calculating the VaR of a credit portfolio

Question 5

What is the difference between 'investment grade' and 'speculative grade' (junk) bonds?

Accepted Answer

Investment grade bonds (BBB-/Baa3 and above) have lower default risk and require less regulatory capital than speculative grade (BB+ /Ba1 and below)

Answer

Investment grade bonds always have higher coupons than speculative grade bonds

Answer

Speculative grade bonds are only issued by governments

Answer

Investment grade bonds cannot be traded in secondary markets

Question 6

What does 'counterparty credit risk' (CCR) refer to in derivatives?

Accepted Answer

The risk that the counterparty to an OTC derivative contract defaults before the contract matures, resulting in a replacement cost loss

Answer

The risk that a central clearinghouse defaults on a futures contract

Answer

The risk that a bond issuer calls the bond before maturity

Answer

The risk that collateral margins are insufficient to cover mark-to-market losses