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FRM Part I · FRM Exam Part I · Measuring Credit Risk

A risk manager notes that rating agency one-year default rates for a given grade are estimated from historical cohorts. Which feature of agency ratings is most likely to make a bank's use of a through-the-cycle rating for a short-horizon credit VaR less precise?

Through-the-cycle ratings are adjusted slowly because they look past temporary cyclical movements. That makes them stable but less sensitive to current conditions, so they can be a less precise input for short-horizon credit risk measures than point-in-time ratings.

  1. AThrough-the-cycle ratings are adjusted slowly, so they respond little to short-term economic changesCorrect
  2. BThrough-the-cycle ratings are recalculated daily using equity prices
  3. CThrough-the-cycle ratings measure only recovery rates, not default likelihood
  4. DThrough-the-cycle ratings are available only for sovereign issuers

Explanation

Through-the-cycle ratings aim for stability by looking through temporary cycle effects, so they change slowly and may not reflect current point-in-time default risk. The other options misstate how such ratings work.

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