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FRM Part II · FRM Exam Part II · Estimating Default Probabilities

A risk analyst at a bank applies the original Altman Z-score model for publicly traded manufacturing firms to a corporate borrower. Using the standard cutoffs, the borrower's Z-score is 1.5. How should the borrower be classified?

The borrower falls in the distress zone. In the original Altman Z-score model, scores below 1.81 signal high bankruptcy risk, scores from 1.81 to 2.99 are the grey zone, and scores above 2.99 are safe. A score of 1.5 is below the lower cutoff.

  1. ASafe zone, because the score is above 1.0
  2. BDistress zone, because the score is below 1.81Correct
  3. CGrey zone, because the score lies between 1.0 and 2.0
  4. DSafe zone, because the score is positive

Explanation

In the original Altman model, scores below 1.81 fall in the distress zone, scores between 1.81 and 2.99 are the grey zone, and scores above 2.99 are in the safe zone. A score of 1.5 is below 1.81, so the borrower is classed as distressed. The grey-zone option uses cutoffs that are not those of the model.

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