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

A risk manager notes that a through-the-cycle (TTC) rating methodology is used by the agency rating a corporate borrower. Compared with a point-in-time (PIT) approach, which implication is most accurate when the economy enters a recession?

TTC ratings are more stable and slower to change, so in a recession they can lag the true deterioration and understate near-term default probability. Realized default rates within a grade still vary with the cycle, and the ratings can still be mapped to PDs.

  1. ATTC ratings migrate more quickly and produce higher rating volatility than PIT ratings
  2. BTTC ratings are more stable, so they may lag deterioration in current default risk and understate near-term PDsCorrect
  3. CTTC ratings are unaffected by the economic cycle, so default rates per grade are constant over time
  4. DTTC ratings cannot be mapped to default probabilities

Explanation

TTC ratings look past cyclical conditions and focus on long-run, stressed-scenario creditworthiness, giving stability but slower reaction. In a downturn, realized default rates per grade still rise, so the rating can understate near-term PD. Option C is wrong because realized default rates per grade remain cyclical.

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