Which of the following is true for the actuarial approach to credit risk modeling (CreditRisk+):
Correct Answer: C
Explanation The actuarial model considers defaults to follow a Poisson distribution with a given mean per period, and these are binary in nature, ie a default happens or it does not happen. The model does not consider the loss of value from credit downgrades, and focuses only on defaults. The model also does not consider default correlations between obligors. Therefore Choice 'c' is the correct answer. The other choices are not true statements that would apply to the actuarial approach.
Question 132
Identify the correct sequence of events as it unfolded in the credit crisis beginning 2007: I. Mortgage defaults increased II. Collapse in prices of unrelated assets as banks tried to create liquidity III. Banks refused to lend or transact with each other IV. Asset prices for CDOs collapsed
Correct Answer: C
Explanation According to a paper by the BCBS, here is an excellent summary of what happened. Based on this, Choice 'c' is the correct answer. "At the outset of the crisis, mortgage default shocks played a part in the deterioration of market prices of collateralised debt obligations (CDOs). Simultaneously, these shocks revealed deficiencies in the models used to manage and price these products. The complexity and resulting lack of transparency led to uncertainty about the value of the underlying investment. Market participants then drastically scaled down their activity in the origination and distribution markets and liquidity disappeared. The standstill in the securitisation markets forced banks to warehouse loans that were intended to be sold in the secondary markets. Given a lack of transparency of the ultimate ownership of troubled investments, funding liquidity concerns were triggered within the banking sector as banks refused to provide sufficient funds to each other. This in turn led to the hoarding of liquidity, exacerbating further the funding pressures within the banking sector. The initial difficulties in subprime mortgages also fed through to a broader range of market instruments since the drying up of market and funding liquidity forced market participants to liquidate those positions which they could trade in order to scale back risk. An increase in risk aversion also led to a general flight to quality, an example of which was the high withdrawals by households from money market funds."
Question 133
Under the ISDA MA, which of the following terms best describes the netting applied upon the bankruptcy of a party?
Correct Answer: A
Explanation Netting is the ability to set just the net balances when amounts are both owed and due. Netting can take many forms. Payment netting is netting between counterparties that owe moneys to each other in the same currency under the same transaction (or master agreement). Closeout netting is when parties settle a net amount for the value of all outstanding transactions upon the occurrence of an event of default such as bankruptcy. Multiateral netting involves a third party that sets off exposures across counterparties that owe moneys to each other. Closeout netting under the ISDA master agreement enables a party to terminate transactions early if an Event of Default or Termination Event occurs in respect of the other party. It involves the calculation and netting of the termination values of all transactions to produce a single amount payable between the parties. Closeout netting is therefore the correct answer.
