FRM FRM Credit Risk 1

Question 1

Which of the following is the correct formula for Expected Loss (EL) in credit risk?

Accepted Answer

EL = PD × LGD × EAD

Answer

EL = PD × EAD / LGD

Answer

EL = LGD × EAD − PD

Answer

EL = PD + LGD + EAD

Question 2

What does Loss Given Default (LGD) represent?

Accepted Answer

The fraction of exposure that is lost when a borrower defaults, after recoveries

Answer

The total dollar amount lost when a counterparty defaults

Answer

The probability that a borrower defaults within a given time horizon

Answer

The market value of collateral held against a credit exposure

Question 3

In the Merton model of credit risk, default occurs when:

Accepted Answer

The value of the firm's assets falls below the value of its debt at maturity

Answer

The firm's stock price drops below its book value

Answer

The firm misses a scheduled interest payment

Answer

Credit spreads widen beyond a regulatory threshold

Question 4

What is a Credit Default Swap (CDS)?

Accepted Answer

A derivative contract where the protection seller compensates the buyer if a reference entity defaults

Answer

An exchange of fixed credit payments for floating interest rate payments

Answer

A bond issued by a bank to transfer credit risk to investors

Answer

A collateralized loan where the borrower pledges fixed-income assets

Question 5

What is the CDS spread most closely related to?

Accepted Answer

The market's implied probability of default of the reference entity

Answer

The risk-free interest rate adjusted for duration

Answer

The coupon rate of the underlying reference bond

Answer

The historical default frequency of similarly rated issuers

Question 6

Which of the following best describes 'wrong-way risk' in derivatives counterparty credit risk?

Accepted Answer

The risk that exposure to a counterparty increases at the same time the counterparty's creditworthiness deteriorates

Answer

The risk that a hedge fails because the hedging instrument moves in the wrong direction

Answer

The risk of loss when a counterparty unexpectedly prepays a loan

Answer

The risk that collateral posted by a counterparty loses value when markets are stressed