Credit Risk Management Practice Exam

What does the term PD stand for in credit risk assessment?

1. Probability of Default

2. Payments Due

3. Payment Duration

4. Possible Deterioration

The correct answer is: Probability of Default

In the context of credit risk assessment, the term PD stands for "Probability of Default." This metric is fundamental in evaluating the credit risk associated with a borrower or a loan. It represents the likelihood that a borrower will fail to meet their debt obligations, typically expressed as a percentage over a specified time frame. Understanding PD is crucial for lenders and financial institutions, as it directly informs their risk management strategies and capital allocation decisions. A higher probability of default suggests a higher level of risk associated with a borrower, leading to more stringent lending criteria, higher interest rates, or increased reserve requirements to mitigate potential losses. The other options, while they may seem relevant to finance, do not accurately reflect the established terminology in credit risk management. "Payments Due" refers to amounts that need to be paid but does not indicate risk. "Payment Duration" is related to the timeframe of payments rather than the risk of default, and "Possible Deterioration" does not specifically relate to the likelihood of default in a quantifiable manner. Thus, PD aligns consistently with the principles of credit risk evaluation, making it the correct choice.