RSK4804
ASSIGNMENT 1 2025
UNIQUE NO. 865733
DUE DATE: 30 MAY 2025
, RSK4804
Assignment 1 2025
Unique Number: 865733
Due Date: 30 May 2025
Credit Risk Management
Question 1
(a) Explain the two most important drivers of credit risk and how those relate to
the probability of default (PD). (5)
Credit risk represents the chance that a borrower or counterparty will not fulfill their
contractual debt obligations, especially the repayment of the principal amount and
interest related to a loan or bond. One of the foundational components in measuring
credit risk is the probability of default (PD), which serves as a forward-looking estimate
of the likelihood that a borrower will default on their financial obligations within a set
timeframe—commonly one year.
Two key factors that significantly influence credit risk and directly affect the PD are:
1. The financial stability and creditworthiness of the borrower, and
2. The prevailing macroeconomic conditions.
The borrower’s creditworthiness is typically evaluated through a range of financial
ratios, historical credit performance, and qualitative aspects such as the strength of
management and the sustainability of the business model. A borrower demonstrating
strong liquidity, profitability, and low financial leverage is generally considered less risky
and is assigned a lower PD. Some vital financial metrics used to assess this include the
debt-to-equity ratio, interest coverage ratio, and the adequacy of operational cash flow.
ASSIGNMENT 1 2025
UNIQUE NO. 865733
DUE DATE: 30 MAY 2025
, RSK4804
Assignment 1 2025
Unique Number: 865733
Due Date: 30 May 2025
Credit Risk Management
Question 1
(a) Explain the two most important drivers of credit risk and how those relate to
the probability of default (PD). (5)
Credit risk represents the chance that a borrower or counterparty will not fulfill their
contractual debt obligations, especially the repayment of the principal amount and
interest related to a loan or bond. One of the foundational components in measuring
credit risk is the probability of default (PD), which serves as a forward-looking estimate
of the likelihood that a borrower will default on their financial obligations within a set
timeframe—commonly one year.
Two key factors that significantly influence credit risk and directly affect the PD are:
1. The financial stability and creditworthiness of the borrower, and
2. The prevailing macroeconomic conditions.
The borrower’s creditworthiness is typically evaluated through a range of financial
ratios, historical credit performance, and qualitative aspects such as the strength of
management and the sustainability of the business model. A borrower demonstrating
strong liquidity, profitability, and low financial leverage is generally considered less risky
and is assigned a lower PD. Some vital financial metrics used to assess this include the
debt-to-equity ratio, interest coverage ratio, and the adequacy of operational cash flow.
