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

A risk manager at a bank compares the credit ratings that two agencies assign to the same corporate borrower. One agency states that its ratings are 'through-the-cycle' (TTC). Which description best fits a through-the-cycle rating approach?

A through-the-cycle rating assesses default risk over a long horizon, assuming stressed or trough conditions, and ignores temporary cyclical fluctuations. This makes ratings stable over time. Point-in-time ratings, by contrast, move with current conditions and market-implied default probabilities.

  1. ARatings are updated promptly to reflect every change in current market-implied default probabilities, so they fluctuate with the credit cycle
  2. BRatings assess the borrower's creditworthiness over a long horizon under stress-like conditions, so they are relatively stable and are not adjusted for temporary cyclical movementsCorrect
  3. CRatings are derived solely from equity-price volatility and the distance to default using a structural model
  4. DRatings are set only for the next 12 months and are reset each year to match the current phase of the economic cycle

Explanation

Through-the-cycle ratings focus on a long-term view of default risk and look through temporary cyclical swings, which makes them stable. The point-in-time approach is the one that reacts quickly to current conditions and market-implied default probabilities, which is the first option's description.

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