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FRM Part II · FRM Exam Part II · Portfolio Credit Risk

A bank's loan portfolio has a large exposure to a single regional energy producer, producing high name concentration. The credit risk manager wants to cut the concentration without damaging the client relationship or selling the loan. Which action best achieves this?

Buying single-name CDS protection on the energy producer is best. It transfers the default risk to the protection seller while the bank keeps the loan and the client relationship, so concentration falls. Repricing, covenants and provisions leave the underlying exposure and its concentration unchanged.

  1. ABuy single-name credit default swap protection on the energy producerCorrect
  2. BIncrease the loan's interest rate to compensate for risk
  3. CTighten covenant monitoring on the loan
  4. DRaise the loan loss provision against the exposure

Explanation

Buying single-name CDS protection transfers the default risk of the reference entity to the protection seller while the loan stays on the books and the relationship is undisturbed. Repricing, covenants and provisioning do not reduce the exposure's contribution to concentration risk.

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