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FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment

A risk analyst reviews a one-year rating transition matrix built from a large sample of corporate issuers. Which statement best describes the row of this matrix for the rating category BB?

The BB row lists the probabilities of ending the period in every rating, including staying at BB and default, so it sums to one. Columns do not sum to one, and the default probability is only a single entry within the row.

  1. AThe probabilities in the row sum to one, covering migration to every other rating, staying at BB, and defaultCorrect
  2. BThe probabilities in the row sum to the one-year default probability of BB issuers
  3. CThe probabilities in the column for BB sum to one across all starting ratings
  4. DThe row contains only downgrade probabilities because upgrades are recorded in a separate matrix

Explanation

Each row gives the distribution of end-of-period states for issuers that start in a given rating. Those states include all ratings, the unchanged rating, and default, so the row sums to one. Column sums need not equal one, and the default probability is only one entry in the row.

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