LO 19.5: Describe the relationship between borrower rating and probability of

LO 19.5: Describe the relationship between borrower rating and probability of default.
Based on the law of large numbers (i.e., a large number of trials will approximate the expected value) and the fact that with a homogeneous population, actual frequencies observed serve as strong predictors of central probabilities, default probabilities can be applied to estimate the future behavior of a population. Not surprisingly, what has been observed is that higher-rated issues have a lower probability of default. The highest-rated issues almost never default even over a period of 10 years, while the lowest-rated issues often default early on and are almost assured of default after a 10-year period.
A g e n c i e s R a t i n g s v s . E x p e r t s -B a s e d A p p r o a c h e s

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