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FRM Part II · FRM Exam Part II · Estimating Default Probabilities

A risk manager notes that a firm's original Altman Z-score is 2.4. Under the conventional cutoffs of the original model, how should the firm be classified?

A Z-score of 2.4 falls in the grey zone, because the original Altman model sets distress below 1.81 and safe above 2.99. Scores between these cutoffs are ambiguous and call for further analysis rather than a clear default or safe classification.

  1. ASafe zone, since the score is above the distress threshold of 1.81
  2. BGrey zone, with the score between 1.81 and 2.99Correct
  3. CDistress zone, since the score is below 2.99
  4. DSafe zone, since a positive score implies no default risk

Explanation

The original model treats Z below 1.81 as distress, above 2.99 as safe, and the range between as the grey (zone of ignorance). 2.4 lies between them. Calling it distress by using 2.99 as the cutoff confuses the upper and lower bounds.

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