P1.T4.19. Role of rating agencies in financial markets

Discussion in 'Today's Daily Questions' started by David Harper CFA FRM CIPM, Mar 21, 2012.

  1. AIMs: Describe the role of rating agencies in the financial markets. Describe some of the market and regulatory forces that have played a role in the growth of the rating agencies.

    Questions:

    19.1. With respect to agency credit ratings, each of the following is true EXCEPT for:

    a. The rating agency market has long been highly concentrated: the "big three" (S&P, Moody's, Fitch) hold at least 90%+ of the market share
    b. Regulators in the U.S. have encouraged the use of credit ratings by explicitly recognizing certain agencies as nationally recognized statistical rating organizations (NRSROs), which are registered with the Securities and Exchange Commission (SEC).
    c. Dodd-Frank attempted (attempts) to strengthen the regulation, and increase the accountability, of credit rating agencies (CRAs)
    d. Dodd-Frank froze the number of NRSROs at five ("increasing to six in 2012") while increasing the references to the use of NRSRO-based ratings in regulations "in order to achieve the consistent requirement of approved credit ratings across regulatory bodies."

    19.2. Each of the following has been, or was at least historically, offered as a criticism of credit rating agencies EXCEPT for:

    a. Issuer-paid credit ratings are a conflict of interest
    b. By disregarding fundamental analysis and relying on Merton-type (market-implied) models, agencies ratings have been plagued with premature over-reaction to market-based events
    c. In the run-up to the crisis, rating agencies were involved, as consultants, in the design of structured products
    d. Agencies designated structured products with the same rating symbols (e.g., AAA) as corporate bonds, implying false comparability between ratings in structured and cash markets

    19.3. Which of the following is most nearly TRUE about agency credit ratings?

    a. Agency ratings are investment advice; e.g., a credit downgrade is analogous to a equity-class sell recommendation
    b. In theory, agency ratings have a longer term orientation (approximating or exceeding the maturity of the instrument) and through-the-cycle, not point-in-time; they do not undulate with business cycles
    c. An agency credit rating is sufficient to price (or value) a debt instrument
    d. Agency ratings, because they are measured on a cardinal scale, correspond directly to probabilities of default (PD; or, expected default frequencies)

    Answers:
  2. Aditi

    Aditi New Member

    19.2-c.
  3. klokwani

    klokwani New Member

    Hey David,

    I'm not sure but the answer link is not working for me. It shows an error whenever I click it.

    Please advice.

    Regards,
    Karan
  4. Hi Karan - It will do that, if you aren't a paid member? Sorry, we need to make a little money. Not a lot. Enough to buy toys and gifts for my nephews and niece, and food for myself ;)
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  5. klokwani

    klokwani New Member

    Hey thats totally fine...I agree with you....no free lunch... How much do I need to pay to access the forum?
  6. Aditi

    Aditi New Member

    Hi David,
    I'm sorry I didnt see that. My bad. I chose "c" because I couldn't recall the event "c". So i checked up in the chapter and found it. Sorry for the mess up and thank you for the answer. :)
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  7. Suzanne Evans

    Suzanne Evans Administrator

    Our FRM products can be found here: https://www.bionicturtle.com/products/financial-risk-management/

    Our lowest tier that offers the forum is the Tier 1 product for $249.

    I hope that helps!

    Thanks,
    Suzanne
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