VRM 4. External and Internal Credit Ratings

Learning Objectives

1) Describe external rating scales, the rating process, and the link between ratings and default.

2) Define conditional and unconditional default probabilities and explain the distinction between the two.

3) Define and use the hazard rate to calculate the unconditional default probability of a credit asset.

4) Define recovery rate and calculate the expected loss from a loan.

5) Explain and compare the through-the-cycle and point-in-time internal ratings approaches.

6) Describe alternative methods to credit ratings produced by rating agencies.

7) Compare external and internal ratings approaches.

8) Describe and interpret a ratings transition matrix and explain its uses.

9) Describe the relationships between changes in credit ratings and changes in stock prices, bond prices, and credit default swap spreads.

10) Explain historical failures and potential challenges to the use of credit ratings in making investment decisions.