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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

A bank compares two rating approaches for its corporate borrowers. Approach X produces ratings that stay largely stable over the business cycle and change only when a borrower's long-run credit quality shifts. Approach Y updates ratings quickly as current conditions, such as market-based default probabilities, change. Which statement correctly classifies these approaches?

Approach X is through-the-cycle because its ratings are stable across the business cycle and change only with long-run credit quality. Approach Y is point-in-time because it updates quickly with current conditions. Through-the-cycle ignores temporary cyclical swings, while point-in-time captures them.

  1. AX is through-the-cycle and Y is point-in-timeCorrect
  2. BX is point-in-time and Y is through-the-cycle
  3. CBoth are through-the-cycle, differing only in rating scale
  4. DBoth are point-in-time, differing only in update frequency

Explanation

Through-the-cycle (TTC) ratings look past temporary cyclical conditions and focus on a borrower's likely performance across the cycle, so they are stable. Point-in-time (PIT) ratings reflect current conditions and move quickly. Approach X is therefore TTC and Y is PIT; the reverse classification is incorrect.

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