1. Which of the following statements is most accurate? The four measures commonly used to quantify credit risk are:
A. credit spread, risk premium, present value of expected loss and recovery rate.
B. probability of default, loss given default, expected loss, and the present value of expected loss.
C. recovery rate, loss given default, expected loss and credit spread.
2. Regarding credit ratings, which of the following statements is least accurate?
A. Credit ratings tend to be stable over time which reduces volatility in debt market prices.
B. Credit ratings do not depend on the business cycle.
C. An issuerpays model does not create an incentive conflict.
3. Which of the following is least likely a strength of the structural model?
A. It gives an option analogy for understanding a company’s default probability.
B. Current market prices can be used to estimate its value.
C. Credit risk measures can be estimated only by using implicit estimation.
Answers: 
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1. B is correct. The credit risk measures for fixedincome securities are: the probability of default, the loss given default, the expected loss, and the present value of the expected loss. Section 2. LO.a.
2. C is correct. The issuerpays model for compensating creditrating agencies has a potential conflict of interest that may distort the accuracy of credit ratings. Credit rating agencies are paid by the issuer and consequently have an incentive to give a higher rating than may be justified. A & B are correct statements regarding credit ratings. Section 3. LO.c.
3. C is correct. For the structural model, one cannot use historical estimation. The reason is that the company’s assets (which include buildings and nontraded investments) do not trade in frictionless markets. Consequently, the company’s asset value is not observable. Because one cannot observe the company’s asset value, one cannot use standard statistics to compute a mean return or the asset return’s standard deviation. This leaves implicit estimation as the only alternative for the structural model. Credit risk measures are biased because implicit estimation procedures inherit errors in the model’s formulation. A & B are structural model strengths. Section 4.4. LO.f.
