LO 18.2: Describe classifications o f credit risk and their correlation with other

LO 18.2: Describe classifications o f credit risk and their correlation with other financial risks.
The concept of credit risk encompasses a range of risk measures. Those relating to default include default risk, recovery risk, and exposure risk. Those relating to valuation include migration risk, spread risk, and liquidity risk. Additional measures include concentration risk and the correlation with pure financial risks (e.g., interest rate, exchange rate, and inflation risks).
Default risk, or counterparty risk, relates to a borrowers inability to make promised payments. Recovery risk is the risk that the recovered amount, in the event of default, is less than the full amount that is due. Exposure risk measures the risk that a credit exposure at the time of default increases relative to its current exposure.
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2018 Kaplan, Inc.
Topic 18 Cross Reference to GARP Assigned Reading – De Laurentis et al., Chapter 2
Migration risk looks at the risk that the credit quality and market value of an asset or position could deteriorate over time. To mitigate this risk, a periodic assessment of the credit quality of assets is necessary, and institutions may need to make credit provisions and record gains and losses. Spread risk is the risk that spreads may change during adverse market conditions as investors require different risk premiums, leading to gains and losses. Liquidity risk is the risk that asset liquidity and values deteriorate during adverse market conditions, lowering their market value.