Financial Risk Management Credit Risk Management 3

Question 1

What is 'default correlation' and why does it matter in portfolio credit risk?

Accepted Answer

The tendency for multiple borrowers to default at the same time, increasing portfolio loss volatility

Answer

Default correlation measures co-movement in defaults; high correlation means multiple defaults cluster together, dramatically increasing tail losses.

Question 2

Under the Basel III Standardized Approach for credit risk, a corporate loan with no external rating receives a risk weight of:

Accepted Answer

100%

Answer

Under Basel III's standardized approach, unrated corporate exposures receive a 100% risk weight for capital calculation purposes.

Question 3

What is 'potential future exposure' (PFE) in counterparty credit risk?

Accepted Answer

The maximum expected exposure to a counterparty at a future date at a high confidence level

Answer

PFE is the statistical worst-case future exposure (typically at 95% or 99% confidence) used for credit limit setting and capital calculations.

Question 4

A credit facility with a 'material adverse change' (MAC) clause protects the lender by:

Accepted Answer

Allowing the lender to cancel or accelerate the loan if the borrower's condition significantly deteriorates

Answer

A MAC clause gives lenders the right to withdraw or restructure facilities if the borrower experiences a significant deterioration in financial condition.

Question 5

Expected Credit Loss (ECL) under IFRS 9 requires banks to recognize:

Accepted Answer

Forward-looking 12-month or lifetime credit losses as soon as a loan is originated

Answer

IFRS 9's ECL model requires immediate recognition of expected losses using forward-looking information, replacing the old incurred loss model.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Credit Risk Management 3