Counterparty risk interview questions
Q1 What do you mean by Risk Probability?
Risk probability refers to the possibility of having a risk event. This possibility can be represented in a quantitative and qualitative manner. Risk probability is expressed qualitatively using terms such as rare, possible, and frequent. Numerical expression utilizes frequencies, percentages, and scores.
Q2 What is a Credit Default Swap?
A credit default swap (CDS) is one of the most5 used methods of mitigating risk in fixed-income, debt security instruments like bonds, and is considered as the most common financial derivatives. credit default swap (CDS) is essentially a type of investment insurance that allows the buyer to mitigate his investment risk by shifting risk to the seller of a CDS in exchange for a fee and the seller of the CDS stands in the position of guaranteeing the debt security in which the buyer has invested.
Q3 What is the reason for high profiting sales to mitigate credit risk?
It is observed that high profit sales reduce credit risk by providing a greater profit incentive in case the borrower is unable to pay the debt. Credit risk is concerned with the likelihood that the borrower is not financially able to pay the debt. The less likely the debt may be paid, the higher the credit risk. This is related to the risk-return trade-off.
Q4 What does a 'Z score refers to?
Z score refers to a Predictive coefficient of Corporate failure developed by Edward Altman
Q5 What is the aim of performing risk analysis?
The aim of performing risk analysis is to best obtain collateral and security for the credit.
Q6 What does trade debtors refer to?
It refers to debts owed to the company by customers of the company on credit terms
Q7 What do you mean by Credit Risk?
Credit risk is the possibility for a loss to occur due to the failure of a borrower to meet its contractual obligation to repay a debt. For example, a homeowner may stop making mortgage payments. This is also called ‘default risk’ or ‘counter-party risk’, and pertinent credit events may include bankruptcy, failure to pay, loan restructuring, loan moratorium, or accelerated loan payments.
Q8 What is Operational Risk?
Operational Risk is the loss occurred due to a business’ operations i.e. process, human resources, systems, external events. It also comes about through external events such as political, legal, and fraud risks.
Q9 Define Market Risk?
Market risk is the Risk caused by unexpected changes in market factors such as interest rates, stock prices, commodity prices, and foreign exchange rates
Q10 How is Credit Risk measured and on what does it depend upon?
Credit risk exposure is measured by the current mark to market value. The magnitude of credit risk depends on the likelihood of default by the counter party the potential value of outstanding contracts the extent to which legally enforceable netting arrangements allow the value of offsetting contracts the value of the collateral held against the contracts
Q11 What is a Collateral?
Collateral represents a repayment source in the worst-case scenario. Most banks require that the loan be 100 per cent collateralized. This means that the business has to have enough collateral to cover 100 per cent of the loan amount. For example, if a loan for Rs.50 lacs is needed, then a car, equipment, building, and inventory must to possessed that add up to Rs.
Q12 What is the most common risk Metric In Loans?
Most common risk metric is the adequacy of loan loss provisions and the size of the loan loss reserve in relationship to the total exposures of the bank. Allowance for loan losses creates a cushion of credit losses in the bank’s credit portfolio. Primarily it is intended to absorb the bank’s expected loan losses. Historically credit decisions were made in a case by case basis.
Q13 Name some common faults experienced in credit risk management.
The common faults experienced in credit risk management are, Absence of written policies Absence of portfolio concentration limits Poor industry analysis Inadequate financial analysis of borrowers Credit rationing contributing to deterioration of loan quality Excessive reliance on collateral.
Q14 How often does the company refresh its assessment of the top risks?
The enterprise-wide risk assessment process should be responsive to change in the business environment. A robust process for identifying and prioritizing the critical enterprise risks, including emerging risks, is vital to an evergreen view of the top risks.
Q15 How are rows structured in risk assessment matrix?
In a risk assessment matrix, rows can be structured as follows: Catastrophic: Devastating impact on financial standing, business operations or people in the workplace. Critical: Major impact on financial standing, business operations or people in the workplace. Moderate: Very noticeable impact on financial standing, business operations or people in the workplace. Minor: Some impact on financial standing, business operations or people in the workplace. Insignificant: Little to no impact on financial standing, business operations or people in the workplace.
Q16 what Is a Good Debt-to-Equity Ratio?
Debt-to-equity (D/E) ratio is a key, if not the primary, financial ratio considered in evaluating a company's ability to handle its debt financing obligations. The D/E ratio indicates a company’s total debt in relation to its total equity, and it reveals what percentage of a company's financing is being provided by debt and what percentage by equity.
Q17 What is Inflation?
Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.
Q18 How are lending limits set?
A system of credit limits, restricts losses to a level which does not compromise a company’s solvency. Lending limits have to be set taking into account capital and resources. Any limit on credit has to be accompanied by a general limit on all risk assets. This would enable the business to hold a minimum proportion of assets such as cash and government securities whose risk of default is zero.
Q19 What do you mean by diversification?
Diversification involves the spread of lending over different types of borrowers, different economic sectors and different geographical regions. To a certain extent credit limits which help avoid concentration of lending ensures minimum diversification. The spread of lending is likely to reduce serious credit problems. Size however confers an advantage in diversification because large businesses can diversify by industry as well as region.
Q20 How can companies reduce Credit Risk?
Companies can reduce credit risk by, Raising credit standards to reject risky loans Obtain collateral and guarantees Ensure compliance with loan agreement Transfer credit risk by selling standardized loans
Q21 What is a pledge?
A ‘pledge’ is mortgage of a movable property which requires delivery of possession
Q22 Define balance sheet?
The balance sheet or net worth statement is a snapshot of the financial position of a business on a specific date. It shows the value of all assets which is “balanced” between the value of all liabilities or the claims of others against the business and the net worth or the owner’s claims against the business.
Q23 What is an Income Statement?
The income statement, or profit and loss (P&L) statement, shows the net income for the business during the accounting period. It includes income generated, the operating and overhead costs, depreciation on assets, gains or losses on disposal of capital assets and income and expenses. It can be prepared on a cash or accrual basis.
Q24 What is the purpose of a Cash flow Statement?
The cash flow statement can be a statement of past activities or a budget of expected cash inflows and outflows. It shows a complete accounting of debt transactions including principal and interest payments as well as the proceeds from new loans.
Q25 What are the items that are included in cash flow statement but not in income flow statement?
Items included in a complete cash flow but not in an income statement include family living costs, income and expenses, and income taxes.
Q26 What do you mean by Liquidity?
Liquidity is the ability of a business to meet financial obligations as they come due without disrupting the normal operations of the business including paying living expenses, taxes and debt payments.
Q27 What does ROE Indicate?
Return on Equity (ROE) indicates the rate of return on equity capital and is particularly on equity capital significant in the context of objective of maximization of share value. Equity is the sum of share capital, preferred shares, paid-in surplus, retained earnings and reserves for future contingencies.
Q28 What does Modern Finance theory Imply?
Modern finance theory implies that declining credit may not necessarily be the proper response to low credit quality. The view of modern theory about risk postulate is that the necessary return should be adjusted for the risk taken. If the risk has been correctly calculated then, losses will be compensated by gains elsewhere.
Q29 What is Loss given default (LGD)?
The LGD is the ratio of the loss on an exposure caused by the default of the counterparty to the amount outstanding at default. This ratio is calculated by businesses following the Internal Ratings-Based Approach (IRBA) for their retail portfolios. The estimated LGDs are necessary for the capital requirement of the institute because of incurred credit risk. The pricing process of credits is also highly affected by an accurate estimation of possible losses.