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FRM Part II · FRM Exam Part II · Estimating Default Probabilities

A bank's risk committee debates whether to rely on through-the-cycle agency ratings or point-in-time internal ratings for monitoring its loan book during a sharp downturn. Which statement is most accurate about agency ratings?

Agency ratings are generally through-the-cycle: they focus on long-run creditworthiness and are relatively stable, so they respond more slowly to current conditions than point-in-time ratings. Consequently, realized default rates within a rating class still vary with the business cycle.

  1. AAgency ratings tend to be relatively stable over the cycle, so they adjust more slowly to changes in current conditions than point-in-time ratings.Correct
  2. BAgency ratings are point-in-time and fully reflect current market prices of credit risk.
  3. CAgency ratings are revised daily to match movements in credit spreads.
  4. DAgency ratings are designed so default rates for each class are constant each year.

Explanation

Agencies rate through the cycle, aiming to avoid frequent reversals, so ratings change gradually and lag current conditions. Realized default rates within a rating class still vary with the economy, so constant rates are wrong. Ratings are not tied to daily spreads.

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