Skip to content

FRM Part II · FRM Exam Part II · Credit Value at Risk

A risk analyst at a bank uses the CreditMetrics approach to estimate the credit VaR of a single corporate bond. Which set of inputs is required to build the distribution of the bond's possible values at the risk horizon?

CreditMetrics needs the current rating, a transition matrix, forward credit spread curves by rating, and recovery rates. These allow revaluation of the bond in every rating state at the horizon, including default, which produces the value distribution from which credit VaR is taken.

  1. ACurrent rating, a rating transition matrix, recovery rates by seniority, and forward credit spread curves for each ratingCorrect
  2. BCurrent equity price, equity volatility, and the face value of debt due at the horizon
  3. CHistorical default counts by sector and a macroeconomic factor model for the default rate
  4. DBond duration, yield volatility, and a parametric normal assumption for price changes

Explanation

CreditMetrics revalues the bond at the horizon under each possible rating state. This needs the transition probabilities, forward spread curves to discount the cash flows in each non-default state, and recovery rates for the default state. The equity-based option describes a structural (KMV-style) approach; the others do not produce rating-based revaluation.

Did you get it right without looking?

One question tells you little. A timed set on Credit Value at Risk shows your real accuracy, how long you take and where you lose marks.

Practise Credit Value at RiskFree diagnostic mock

More Credit Value at Risk questions