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FRM Part II · FRM Exam Part II · Credit Scoring and Rating

A risk analyst at a bank compares two ways of assigning ratings to corporate borrowers. Approach X reflects a borrower's creditworthiness over a full economic cycle and changes only when the borrower's long-run credit quality changes. Approach Y reflects the borrower's current condition and moves quickly with changing economic conditions. Which description correctly characterizes these approaches?

Approach X is through-the-cycle because it looks through the economic cycle and changes only when long-run credit quality changes. Approach Y is point-in-time because it reflects current conditions and reacts quickly. Through-the-cycle ratings are stable, while point-in-time ratings are more volatile and procyclical.

  1. AX is a through-the-cycle approach and Y is a point-in-time approachCorrect
  2. BX is a point-in-time approach and Y is a through-the-cycle approach
  3. CBoth X and Y are through-the-cycle approaches that differ only in rating scale
  4. DBoth X and Y are point-in-time approaches that differ only in rating horizon

Explanation

Through-the-cycle ratings look past temporary cyclical swings and focus on long-run credit quality, so they are stable. Point-in-time ratings incorporate current conditions and so migrate more with the cycle. Option B reverses the two definitions.

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