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FRM Part II · FRM Exam Part II · Credit Risk Management

Which of the following is the most appropriate use of a credit rating transition matrix in credit risk management?

A rating transition matrix shows the probabilities that a borrower moves from one rating grade to another, or to default, over a set horizon. That makes it useful for assessing migration risk and default probabilities, not recoveries, haircuts or leverage ratios.

  1. AEstimating the probability that a borrower migrates to another rating grade or defaults over a given horizonCorrect
  2. BDetermining the recovery rate on a defaulted bond
  3. CCalculating the collateral haircut on a repo
  4. DSetting the bank's regulatory leverage ratio

Explanation

A transition matrix gives probabilities of moving between rating grades, including default, over a horizon, which supports migration and credit VaR analysis. It does not estimate recoveries, haircuts or leverage ratios.

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