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

A credit committee wants a rating system for pricing short-term loans and for dynamic provisioning that responds promptly to deterioration in borrowers' conditions. Which feature is most appropriate?

A point-in-time system is most appropriate, because it updates default probability estimates with current borrower and economic information. This suits short-term loan pricing and prompt provisioning, whereas through-the-cycle ratings are deliberately stable and respond slowly to deterioration, making them better for long-horizon capital planning.

  1. AA through-the-cycle system, because stable grades avoid frequent repricing
  2. BA point-in-time system, because it updates default estimates with current information on borrower and economic conditionsCorrect
  3. CA system using only agency ratings, since they never lag the market
  4. DA system that fixes PD at the long-run average for all grades

Explanation

Pricing short-term loans and provisioning need default probabilities that reflect current conditions, which PIT ratings provide. TTC ratings are stable and suit long-horizon capital planning, but they respond slowly. Fixing PD at long-run averages ignores current deterioration entirely.

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