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

A bank's risk committee notes that external agency ratings tend to change slowly even when a borrower's market-implied credit quality deteriorates quickly. Which feature of the agencies' rating methodology best explains this behavior?

Agency ratings are designed to be through-the-cycle, filtering out temporary credit fluctuations and changing only when credit quality shifts durably. That stability explains why ratings lag market-implied measures such as CDS spreads or equity-based indicators when a borrower's condition deteriorates quickly.

  1. ARatings are intended to be through-the-cycle, so they filter out short-term fluctuations in credit conditionsCorrect
  2. BRatings are calculated mechanically from daily equity prices, which are stable
  3. CRatings measure only loss given default and ignore probability of default
  4. DRatings are updated every day to match credit default swap spreads

Explanation

Agencies aim for through-the-cycle ratings that look past temporary swings and adjust only when a change in credit quality is judged to be lasting. This makes ratings stable but slow to reflect market-implied deterioration. The other options misstate the methodology: ratings are not daily-updated, equity-price-driven, or LGD-only.

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