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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

Which of the following is a recognized conflict-of-interest criticism of the issuer-pays model used by major rating agencies?

The criticism is that issuers pay for their own ratings, so agencies may inflate ratings to win or keep business. Issuers can also shop among agencies. This conflict was especially cited for complex structured products in the 2007-2009 crisis.

  1. AAgencies may be tempted to give favorable ratings to retain issuers who pay their fees, particularly for complex structured productsCorrect
  2. BAgencies are paid by investors who therefore prefer lower ratings to buy bonds cheaply
  3. CAgencies cannot observe issuer financial statements and must rely on market prices only
  4. DAgencies are prohibited from rating more than one security per issuer, which limits revenue

Explanation

Under issuer-pays, the rated entity pays the fee, creating an incentive for ratings shopping and inflated ratings, notably for structured finance before 2007-09. The other options misstate who pays, the information used, or agency rules.

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