Skip to content

FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment

A credit analyst uses the KMV approach and finds a firm has a market value of assets of 500, a default point (short-term debt plus half of long-term debt) of 350, and annual asset volatility of 20% in value terms of 100 (i.e., 20% of 500). What is the distance to default in standard deviations?

Distance to default is 1.50 standard deviations: the 150 cushion between asset value of 500 and the default point of 350, divided by the asset volatility of 100 (20% of 500). A larger distance means a lower expected default frequency.

  1. A1.50Correct
  2. B0.70
  3. C3.50
  4. D1.00

Explanation

Distance to default = (asset value - default point) / asset volatility in value terms = (500 - 350) / 100 = 1.50. Using 350/100 gives 3.50 (ignoring the asset value). Dividing by 500 instead of 100 gives 0.30-type errors; 0.70 is 350/500.

Did you get it right without looking?

One question tells you little. A timed set on Introduction to Credit Risk Modeling and Assessment shows your real accuracy, how long you take and where you lose marks.

Practise Introduction to Credit Risk Modeling and AssessmentFree diagnostic mock

More Introduction to Credit Risk Modeling and Assessment questions