Credit Risk Management Practice Exam

How does the payment frequency affect credit exposure?

1. It does not have any effect

2. More frequent payments result in increased exposure

3. Unequal payments can reduce exposure

4. Payments made in advance increase exposure

The correct answer is: Unequal payments can reduce exposure

The relationship between payment frequency and credit exposure is nuanced, particularly when considering unequal payment structures. When a borrower makes payments that are not uniform over time (i.e., some payments are larger or scheduled for different intervals), the lender's exposure to credit risk can indeed be reduced. This reduction in exposure can occur because receiving larger payments earlier can mitigate the risk of default over time. With unequal payments, if a borrower defaults after making substantial initial payments, the lender has already recouped a significant portion of the loan amount, which lowers the potential loss. Furthermore, if payments are structured in such a way that they front-load repayments—meaning larger payments come first—this can decrease the overall credit exposure earlier in the payment schedule, which is a positive risk management strategy. In the context of the other options, while the frequency of payments can influence exposure, the specifics of payment amounts and timing play a more critical role. For instance, equal and more frequent payments might not necessarily increase exposure, as they can also offer more opportunities for collateral recovery or reduce the time the lender is exposed to the borrower’s credit risk. Payments made in advance could influence exposure in different ways, as they could either signal strong borrower capacity or create potential short-term liquidity issues for