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

Choice 'c' is the correct answer. The Markov property is the assumption that there is no ratings momentum, and that transition probabilities are dependent only upon where the rating currently is and where it is going to. Where it has come from, or what the past changes in ratings have been, have no effect on the transition probabilities. ('Herstatt risk' refers to settlement risk, and is irrelevant.)

Bank B's exposure is measured by the price it paid for the bonds, which in this case is $7m ($10m x 70/100). Hence Choice 'c' represents the correct answer.

(Note that the question is asking for 'exposure' and not the legal claim in the event of default. The legal claim in the event of default would be the full notional of $10m. )

The initial issue price and issue size are irrelevant.

The recovery rate, the default hazard rate (also called the average default intensity) and the spread on debt are linked by the equation Hazard Rate = Spread/(1 - Recovery Rate). Therefore, the recovery rate implicit in the given data is = 1 - 8%/10% = 20%.