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Answer: As the economy moves from a period of high growth to a period of low growth, a rating produced using a point-in-time approach is more likely to change than a rating produced using a through-the-cycle approach.
## Explanation **Correct Answer: A** **Key Concepts:** - **Through-the-cycle (TTC) ratings**: These ratings aim to be stable over the economic cycle and are less sensitive to temporary economic fluctuations. They focus on long-term fundamentals. - **Point-in-time (PIT) ratings**: These ratings reflect current conditions and are more sensitive to economic cycles and short-term fluctuations. **Analysis:** - When the economy transitions from high growth to low growth, PIT ratings are more likely to change because they incorporate current economic conditions and are more responsive to cyclical changes. - TTC ratings are designed to be more stable and less affected by temporary economic downturns, as they focus on the borrower's ability to withstand economic stress over a full cycle. **Why other options are incorrect:** - **B**: Actually, external rating agencies typically use TTC approaches for stability, while banks often use PIT approaches for internal ratings to better reflect current risk. - **C**: External rating agencies use outlooks for medium-term changes (6 months to 2 years) and watchlists for near-term changes (90 days). - **D**: Banks use comprehensive internal rating systems that include both quantitative and qualitative factors, not just financial ratios.
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A newly hired risk analyst at a large commercial bank is studying the methodologies used by banks and external rating agencies to generate and communicate credit ratings of credit instruments, firms, and sovereign issuers. The analyst compares common approaches to producing internal and external ratings, and examines the differences between through-the-cycle and point-in-time ratings. Which of the following statements should the analyst find to be correct?
A
As the economy moves from a period of high growth to a period of low growth, a rating produced using a point-in-time approach is more likely to change than a rating produced using a through-the-cycle approach.
B
A bank's internal ratings are more likely to be produced using a through-the-cycle approach, while ratings from external agencies are more likely to be produced using a point-in-time approach.
C
External rating agencies use outlooks to indicate a near-term change in a rating, while using watchlists to indicate a medium-term change in a rating.
D
Banks typically produce internal ratings based solely on a set of financial ratios related to the borrower's leverage and earnings.
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