Explanation:
Wrong-way risk represents the problem that collateral values decrease simultaneously with an increase in default potential. The use of collateral with value positively correlated with the value of the borrower is the problem here. The other selections are not correct.
(Book 1, Module 4.1, LO 4.b)
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Question 9
Banks have traditionally relied on collateral when justifying the yes/no loan decision. The idea is that collateral mitigates the bank's exposure. As a traditional credit risk mitigator, collateral appears to provide benefits. However, there is a potential problem with collateral use. Which of the following risks represents the biggest potential shortcoming of collateral?
A
Collateral appraisal risk.
B
Regulatory collateral risk.
C
Wrong-way risk.
D
Right-way risk.
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