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

A bank uses a TTC rating scale for Grade B, mapped to a long-run average one-year PD of 4.0%. In a benign year, the PIT PD for Grade B borrowers is estimated at 2.5%. The bank holds a portfolio of USD 200 million exposure to Grade B borrowers with LGD of 40% and uses a one-year horizon. What is the difference between expected loss using the TTC PD and the PIT PD, and what does it imply?

The difference is USD 1.2 million, with the through-the-cycle figure higher. TTC expected loss is 4.0% × 40% × 200 million = 3.2 million, versus 2.5% × 40% × 200 million = 2.0 million for point-in-time, so TTC is conservative during a benign year.

  1. AUSD 1.2 million; TTC expected loss is higher, so the TTC figure is conservative in a benign yearCorrect
  2. BUSD 3.0 million; TTC expected loss is higher because TTC uses current conditions
  3. CUSD 1.2 million; PIT expected loss is higher because it reflects stress
  4. DUSD 0.5 million; TTC expected loss is lower because it averages the cycle

Explanation

EL(TTC) = 4.0% × 40% × 200m = USD 3.2m. EL(PIT) = 2.5% × 40% × 200m = USD 2.0m. Difference = USD 1.2m, with TTC higher. In a benign year the PIT PD sits below the long-run average, so TTC is conservative. The third option reverses which is higher.

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