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

A one-year rating transition matrix shows that 8% of bonds rated BBB at the start of the year were rated A at year-end, 84% stayed BBB, 6% were downgraded to BB or lower (non-default), and 2% defaulted. Which statement about the BBB row of this matrix is correct?

The one-year default probability for a BBB bond is 2%, the default entry in its row. The row includes every end-state, including default, so it sums to 100%. The upgrade probability is 8% and the non-default downgrade probability is 6%.

  1. AThe one-year probability that a BBB bond defaults is 2%Correct
  2. BThe one-year probability that a BBB bond is upgraded is 92%
  3. CThe row sums to 98% because default is excluded
  4. DThe one-year probability that a BBB bond is downgraded to BB or lower, excluding default, is 8%

Explanation

Each row of a transition matrix covers all end-of-year states, including default, and sums to 100% (8+84+6+2). The default probability is the 2% entry. Upgrade probability is 8%, not 92%, and the 6% is the non-default downgrade probability, not 8%.

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