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FRM Part II · FRM Exam Part II · Credit Value at Risk

When CreditMetrics revalues a non-defaulted bond at the end of the horizon after a migration to a new rating, which inputs are used?

CreditMetrics revalues the bond by discounting its remaining cash flows at forward zero-curve rates appropriate to the new rating category, so the credit spread reflects the migrated rating. Only in default is value set to an estimated recovery rate on face value.

  1. AThe bond's remaining cash flows discounted at forward zero-curve rates for the new rating categoryCorrect
  2. BThe original yield-to-maturity held constant regardless of the new rating
  3. CThe par value of the bond for every non-default state
  4. DThe average historical price of bonds in the new rating class

Explanation

In each non-default state, the remaining cash flows are discounted using forward zero curves specific to the new rating, which reflects the credit spread for that class. Default state uses a recovery rate times face value. Holding the original yield or par ignores spread changes.

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