Credit Risk Management Practice Exam

How can financial institutions treat Counterparty Credit Risk (CCR)?

1. Only as a credit risk

2. Only as a market risk

3. Either as credit risk or market risk

4. As a non-relevant factor in risk modeling

The correct answer is: Either as credit risk or market risk

Financial institutions can treat Counterparty Credit Risk (CCR) as either credit risk or market risk, depending on the context in which the risk is assessed and the underlying exposure involved. When dealing with financial contracts such as derivatives or securities financing transactions, CCR arises because the counterparty might default on its obligations, making it a credit risk. In this case, the assessment involves evaluating the likelihood of default and the potential loss in the event of that default. Financial institutions often employ various models to measure the expected and unexpected losses associated with this credit risk. On the other hand, CCR can also have market risk implications. Changes in market conditions can affect the value of the underlying collateral or the exposure itself, leading to fluctuations in the value that could impact the financial position of the institution. For instance, if the market value of a derivative contract declines significantly, the associated risk may be assessed with respect to market fluctuations and the potential for losses due to changing market prices. Therefore, the dual nature of CCR allows financial institutions to assess it through both lenses, making it essential to consider the context of the transaction and the relevant market factors. This comprehensive approach enables organizations to better manage their overall risk exposure and implement appropriate risk mitigation strategies.