FRM Part I · FRM Exam Part I · External and Internal Credit Ratings
An agency's rating history shows that for BB-rated issuers the cumulative default rate is 1.0% at year 1 and 3.0% at year 2. What is the marginal (conditional) default probability in year 2, given survival through year 1?
The conditional year-2 default probability is 2.02%. Survival is 99% after year 1 and 97% after year 2, so the conditional default rate is the 2% drop divided by 99% survivors, not simply 2%.
- A2.00%
- B2.02%Correct
- C3.00%
- D1.98%
Explanation
Survival to year 1 is 99%; survival to year 2 is 97%. Marginal default in year 2 = (0.99 - 0.97)/0.99 = 0.0202, i.e. 2.02%. Simply subtracting 1% from 3% gives 2.00%, which ignores conditioning on survival.
Did you get it right without looking?
One question tells you little. A timed set on External and Internal Credit Ratings shows your real accuracy, how long you take and where you lose marks.
More External and Internal Credit Ratings questions
- When a bank validates its internal rating system, it finds that borrowers rated in the best grades defaulted at a similar rate to borrowers …
- A risk analyst reviews criticisms of external ratings for structured finance products during the 2007-2009 crisis. Which statement most accu…
- A credit committee wants a rating system for pricing short-term loans and for dynamic provisioning that responds promptly to deterioration i…
- During a recession, a bank's portfolio is rated using a point-in-time (PIT) system and, separately, a through-the-cycle (TTC) system. Which …
- A risk manager notes that observed historical default rates for a given rating differ between the start of a recession and the end of an exp…
- Which feature is generally associated with agency external ratings such as those from major rating agencies, relative to internal ratings bu…