Credit Risk Management Practice Exam

In evaluating credit exposure, what determines funding costs?

1. Merely market conditions

2. Funding and credit exposures

3. Only the transaction size

4. Personal credit histories

The correct answer is: Funding and credit exposures

Funding costs in the context of credit exposure are influenced by various factors, primarily the combination of funding and credit exposures. Funding costs refer to the expenses incurred by a financial institution to secure the necessary capital to lend or invest. These costs are affected by the creditworthiness of borrowers, which is assessed through credit exposure. If the credit exposure is considered high risk, the cost of funding will increase as lenders will demand a higher return for providing capital to accommodate that risk. Additionally, when financial institutions assess their credit exposures, they take into account the sources of their funding, whether it be through deposits, borrowings, or other financial instruments. The efficiency and terms of these funding methods also play a significant role in determining overall funding costs. Thus, a thorough understanding of both funding mechanisms and the related credit exposures is essential for accurately assessing funding costs in the context of credit risk management.