Skip to content

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

A rating agency's one-year transition matrix shows that a BBB-rated bond has a 4% probability of being upgraded to A, 86% of staying BBB, 6% of being downgraded to BB, and 3% of being downgraded to B, with the remainder defaulting. What is the probability that the bond defaults within one year, and what is the probability of a downgrade (including default)?

Default probability is 1%, since the listed outcomes sum to 99% and the remainder defaults. The probability of a downgrade including default is 6% plus 3% plus 1%, which equals 10%. Leaving out the default state gives 9%, which is incorrect.

  1. A1% default; 10% downgrade including defaultCorrect
  2. B1% default; 9% downgrade including default
  3. C4% default; 13% downgrade including default
  4. D0% default; 9% downgrade including default

Explanation

Probabilities sum to 100%: 4+86+6+3 = 99, so default = 1%. Downgrade including default = 6+3+1 = 10%. The 9% option omits default from the downgrade total.

Did you get it right without looking?

One question tells you little. A timed set on External and Internal Credit Ratings shows your real accuracy, how long you take and where you lose marks.

Practise External and Internal Credit RatingsFree diagnostic mock

More External and Internal Credit Ratings questions