Credit Risk Analysis Flashcards
6 cards from real Financial Risk Management practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 6 Credit Risk Analysis flashcards as text
What is a 'credit rating migration matrix' used for in credit risk?
Answer: Quantifying the probability of a borrower moving from one credit rating to another over a given period
A migration matrix shows historical transition probabilities between credit rating categories (e.g., AAA to AA, BBB to default) over a one-year horizon.
What is 'credit spread' in fixed income markets?
Answer: The yield difference between a corporate (or risky) bond and a risk-free government bond of the same maturity
The credit spread compensates investors for taking on default risk relative to a risk-free benchmark; wider spreads indicate higher perceived credit risk.
What is 'default correlation' and why does it matter for credit portfolios?
Answer: The tendency of multiple borrowers to default at the same time, which affects portfolio credit losses during economic downturns
High default correlation means losses are concentrated — when one borrower defaults, others tend to default too, making diversification less effective and tail losses worse.
What is the Z-score model (Altman) primarily used for?
Answer: Predicting the probability of corporate bankruptcy using financial ratios
Altman's Z-score combines five financial ratios (profitability, leverage, liquidity, solvency, activity) into a single score to predict corporate financial distress within two years.
What is the difference between 'investment grade' and 'speculative grade' (junk) bonds?
Answer: Investment grade bonds (BBB-/Baa3 and above) have lower default risk and require less regulatory capital than speculative grade (BB+ /Ba1 and below)
The investment grade / speculative grade divide at BBB-/Baa3 is a critical regulatory boundary affecting institutional investor mandates, capital requirements, and market access.
What does 'counterparty credit risk' (CCR) refer to in derivatives?
Answer: The risk that the counterparty to an OTC derivative contract defaults before the contract matures, resulting in a replacement cost loss
CCR is bilateral — either counterparty could default — and the exposure varies over time with the mark-to-market of the derivative, unlike loans with fixed exposures.
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