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FRM Part II · FRM Exam Part II · Credit Risk Management

A risk analyst compares a bank's internal rating system with an agency's external ratings. The bank wants ratings that reflect the borrower's creditworthiness over a full economic cycle and change little as conditions move. Which type of rating philosophy matches this goal?

Through-the-cycle rating matches the goal. It assesses a borrower's credit quality over a full economic cycle, ignoring short-term fluctuations, so ratings are stable. Point-in-time ratings respond quickly to current conditions and therefore change more frequently and procyclically.

  1. APoint-in-time, because it reacts quickly to current conditions
  2. BThrough-the-cycle, because it focuses on long-run stressed-adjusted default risk and is stableCorrect
  3. CMarket-implied, because it follows daily credit spreads
  4. DRecovery-based, because it ranks facilities by loss severity only

Explanation

Through-the-cycle ratings assess borrower quality across a full cycle and so migrate less often. Point-in-time ratings use current conditions and are more volatile, so they do not meet the stability goal.

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