GARP Updated 2016-FRR Exam Questions and Answers by maisy

Credit derivatives historically carry several specific types of risk:

Documentation Risk:The risk arising from the complexity and potential ambiguity in the legal documentation of credit derivative contracts.

Definition of Credit Events:The risk associated with the precise definition of what constitutes a credit event, such as a default, which can be subject to interpretation and affect payouts.

Occurrence of Credit Events:The actual risk that a credit event will occur, triggering the derivative contract.

Enterprise risk is a broader category that typically includes all risks faced by an enterprise, not just those associated with credit derivatives.

References

Verified information on credit derivative risks from the document ​

The incorrect statement about the seniority of corporate bonds is that "Junior bonds always pay higher coupons than subordinated bonds." Junior bonds are also known as subordinated bonds. The coupon rate of bonds is influenced by several factors, including the issuer's credit quality and market conditions, but the statement incorrectly assumes that junior bonds must always have higher coupons than subordinated bonds, which is not necessarily true.

The probability of default (PD) refers to the likelihood that a borrower will fail to meet its debt obligations over a specific time horizon. This is a core component in quantifying credit risk exposures.

Duration of default is not a commonly used term in credit risk analysis.

Exposure at default (EAD) measures the total value at risk in the event of default but does not directly refer to the likelihood of default.

Loss given default (LGD) measures the portion of the exposure that is lost when a borrower defaults but does not indicate the likelihood of default.

While diversifying a bank’s credit portfolio helps spread out credit risks, the goal in debt management is to minimize the impact of defaults, and default risk cannot be fully hedged away, meaning it will always exist for the credit holder or the person insuring against it.

However, it is incorrect to state that the value of loan exposure changes similarly to equity investments. Loan exposures are generally less volatile compared to equities, and their value is typically more stable.