CRA Credit Risk & Counterparty Exposure Flashcards

Which credit enhancement technique involves a third party guaranteeing the debt obligations of a borrower?

Answer: Credit Guarantee

A credit guarantee is a credit enhancement where a third party (guarantor) agrees to fulfill a borrower's debt obligations if the borrower defaults.

The relationship between credit spread and credit quality is best described as:

Answer: Negatively correlated — lower credit quality leads to wider spreads

Credit spreads widen as credit quality deteriorates because investors demand higher compensation for the increased default risk.

What is the primary purpose of a loan covenant in credit risk management?

Answer: To impose conditions on the borrower that protect the lender's interests

Loan covenants are contractual conditions that borrowers must maintain, designed to protect lenders by providing early warning signals of financial deterioration.

Under Basel III, the Leverage Ratio is designed to:

Answer: Provide a non-risk-based backstop to prevent excessive leverage

The Basel III Leverage Ratio serves as a non-risk-sensitive supplementary measure that limits the buildup of leverage in the banking system.

In securitization, a Special Purpose Vehicle (SPV) is used to:

Answer: Isolate financial assets and issue securities backed by those assets

An SPV is a legally separate entity created to isolate financial assets from the originator, enabling the issuance of asset-backed securities (ABS) with credit risk transfer.

The concept of 'through-the-cycle' (TTC) credit ratings differs from 'point-in-time' (PIT) ratings in that TTC ratings:

Answer: Represent long-run average credit quality and remain stable across economic cycles

Through-the-cycle (TTC) ratings assess a borrower's creditworthiness across full economic cycles, providing stable ratings less sensitive to short-term fluctuations.