Financial Risk Management Credit Risk Analysis

Question 1

What does 'Probability of Default' (PD) measure in credit risk?

Accepted Answer

The likelihood that a borrower will fail to meet its debt obligations within a specified time horizon

Answer

The loss given a default event

Answer

The exposure at default for a loan

Answer

The recovery rate on a defaulted bond

Question 2

In the credit risk formula Expected Loss = PD × LGD × EAD, what does LGD stand for?

Accepted Answer

Loss Given Default

Answer

Loan Growth Differential

Answer

Liquidity Gap Duration

Answer

Leverage Gross Discount

Question 3

What is 'Exposure at Default' (EAD) for an undrawn revolving credit facility?

Accepted Answer

An estimate of the outstanding amount at the time of default, including expected drawdowns before default

Answer

Always zero because the facility has not been drawn

Answer

The current drawn balance only

Answer

The total facility limit regardless of current utilization

Question 4

Which credit risk model uses equity prices and balance sheet data to estimate the distance-to-default?

Accepted Answer

KMV/Merton structural model

Answer

CreditMetrics (JP Morgan)

Answer

CreditRisk+ (Actuarial model)

Answer

Altman Z-Score model

Question 5

What is a Credit Default Swap (CDS)?

Accepted Answer

A derivative where the protection buyer pays periodic premiums and receives a payment if a reference entity defaults

Answer

A bond that converts to equity upon default

Answer

An exchange-traded futures contract on corporate bond spreads

Answer

A loan participation agreement between two banks

Question 6

What does a 'wrong-way risk' mean in the context of counterparty credit risk?

Accepted Answer

The risk that the counterparty's probability of default is positively correlated with the exposure value

Answer

The risk that a hedge moves in the same direction as the exposure

Answer

The risk that the mark-to-market value of a derivative is always negative

Answer

The risk that collateral posted decreases in value during a default event