[ 2009 FRM Sample Exam ] Quantitative Analysis Q2 companies, approved, business, expected, interest

lalamei

 

2. The peak credit exposure and expected loss of a 5-year USD 100 million interest rate swap have been simulated to be USD 8 million and USD 0.2 million respectively. As a credit risk manager, you have just approved such a swap with a counterparty rated AA by S&. Now, you are required to make a decision on approving a new and identical interest rate swap with another counterparty that is rated BB by S&. Assuming that the two counterparties are companies with identical business risks and environment, choose the correct option from the following table regarding the new interest rate swap

 [attach]13797[/attach] 

A. Please see table in question.

B. Please see table in question.

C. Please see table in question

D. Please see table in question

 

[此贴子已经被作者于2009-6-13 10:47:54编辑过]

lalamei

 

Correct answer is C

A is incorrect as the expected loss which is a function of probability of default should be higher than USD 0.2mn given the lower S& credit rating (BB) of the new counterparty.

B is incorrect as the peak credit exposure, which is not a function of the credit profile of the counterparty, should be the same (i.e. USD 8mn) as the two interest rate swaps are identical.

C is correct as the peak credit exposure is the same (i.e. USD 8mn) as the two interest rate swaps are identical. Also, the expected loss should be higher than that of the earlier transacted swap as the new counterparty is of a lower credit profile.

D is incorrect as the credit exposure which is not a function of the credit profile of the counterparty, is lower from the earlier transacted interest rate swap. Also, the expected loss which is a function of probability of default should be higher than USD 0.2mn given the lower S& credit rating (BB).

Reference: John B. Caouette, Edward I. Altman, and Paul Narayanan, Managing Credit Risk (New York: Wiley, 1998) Chapter 21