Explanation

To calculate the 1-year 95% credit VaR, we need to find the credit loss that corresponds to the 95th percentile of the loss distribution.

Step 1: Calculate cumulative probabilities

• B rating: 0.25% probability
• CCC rating: 0.15% probability
• Default: 0.25% probability

Step 2: Determine cumulative distribution

• Default (0.25%): Loss = USD 100 (full face value)
• CCC (0.15%): Loss = USD 60 (assuming 40% recovery rate, typical for CCC)
• B (0.25%): Loss = USD 20 (assuming 80% recovery rate, typical for B)

Step 3: Find 95% VaR

Looking at the cumulative probabilities:

• Default + CCC + B = 0.25% + 0.15% + 0.25% = 0.65% cumulative probability
• This is below 5%, so we need to consider additional transitions

Since the total probability shown is only 0.65%, we need to consider that the remaining 99.35% represents staying in the original rating or transitioning to higher ratings with minimal or no loss.

At 95% confidence level, we are looking at the 5th percentile of the loss distribution. Given the small probabilities of downgrade/default, the 95% VaR would be:

• The loss level that exceeds 5% of the distribution
• With only 0.65% probability of significant losses, the 95% VaR would be relatively small
• USD 18 represents an appropriate estimate given the low probabilities of downgrade

The correct answer is B. USD 18 as it represents a reasonable estimate of the 95% credit VaR given the transition probabilities provided.