8008 Exam Dumps : PRM Certification - Exam III: Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP - 2015 Edition

The correct answer is Choice 'b'. The following is a brief description of the major approaches available to model credit risk, and the analysis that underlies them:

1. CreditMetrics: based on the credit migration framework. Considers the probability of migration to other credit ratings and the impact of such migrations on portfolio value.

2. CreditPortfolio View: similar to CreditMetrics, but adds the impact of the business cycle to the evaluation.

3. The contingent claims approach: uses option theory by considering a debt as a put option on the assets of the firm.

4. KMV's EDF (expected default frequency) based approach: relies on EDFs and distance to default as a measure of credit risk.

5. CreditRisk+: Also called the 'actuarial approach', considers default as a binary event that either happens or does not happen. This approach does not consider the loss of value from deterioration in credit quality (unless the deterioration implies default).

The distance to default is the number of standard deviations that expected asset values are away from the default point. The expression in Choice 'd' represents distance to default. Choice 'd' is the correct answer. The other choices are incorrect.

The minimum variance hedge ratio answers the question of how much of the hedge to buy to hedge a given position. It minimizes the combined volatility of the primary and the hedge position. The minimum variance hedge ratio is given by the expression [ σ(x) / σ(y) ] * ρ(x,y)]. Effectively, this is the same as the beta of the primary position with respect to the hedge.

In this case, the hedge ratio is = 10%/9% * 0.9 = 1