Question #17 - Reading 28 Credit Analysis Models

Reading: Reading 28 Credit Analysis Models

PDF File: Reading 28 Credit Analysis Models.pdf

Page: 7

Status: Correct

Correct Answer: B

Shared Context

- Based on Exhibit 1 and a par value of $100, the expected loss on the Alligator bond in year 2 is closest to: A) $0.5718. B) $0.5737. C) $0.5789.

Question

The summary provided in Exhibit 2 is best described as:

Answer Choices:

A. accurate

B. inaccurate in regards to default risk

C. inaccurate in regards to parameter estimation

Explanation

Unlike structural models of credit risk, which treat default risk as an endogenous variable (i.e., when the value of the assets is less than the face value of debt), reduced form models do not explain why default occurs, instead they treat default as a randomly-occurring (exogenous) variable. Reduced form models focus on the severity of loss given default.

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