Try 10 focused CISI Risk questions on Credit Risk, with answers and explanations, then continue with Securities Prep.
| Field | Detail |
|---|---|
| Exam route | CISI Risk |
| Issuer | CISI |
| Topic area | Credit Risk |
| Blueprint weight | 15% |
| Page purpose | Focused sample questions before returning to mixed practice |
Use this page to isolate Credit Risk for CISI Risk. Work through the 10 questions first, then review the explanations and return to mixed practice in Securities Prep.
| Pass | What to do | What to record |
|---|---|---|
| First attempt | Answer without checking the explanation first. | The fact, rule, calculation, or judgment point that controlled your answer. |
| Review | Read the explanation even when you were correct. | Why the best answer is stronger than the closest distractor. |
| Repair | Repeat only missed or uncertain items after a short break. | The pattern behind misses, not the answer letter. |
| Transfer | Return to mixed practice once the topic feels stable. | Whether the same skill holds up when the topic is no longer obvious. |
Blueprint context: 15% of the practice outline. A focused topic score can overstate readiness if you recognize the pattern too quickly, so use it as repair work before timed mixed sets.
These questions are original Securities Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.
Topic: Credit Risk
A bank is calibrating a 12-month probability of default (PD) model for an SME portfolio. Policy says any account with missing 12-month outcome data must be excluded until verified. Round percentages to one decimal place.
Calibration extract:
If an analyst incorrectly codes the missing-status accounts as non-default, which statement is correct?
Best answer: B
What this tests: Credit Risk
Explanation: Coding the missing outcomes as non-default produces a reported PD of 18/1,000 = 1.8%. Because those 120 accounts should have been excluded, the denominator is too large and the credit-risk metric is biased downward.
This tests how data quality and calibration rules affect a credit-risk metric. The valid calibration sample is only the accounts with verified 12-month outcomes, so the benchmark denominator should be 880, not 1,000. If the analyst wrongly treats the 120 missing-status accounts as non-default, the reported PD becomes 18/1,000 = 1.8% instead of 18/880 ≈ 2.0%. That lower figure does not reflect better borrower quality; it reflects poor data treatment in the calibration sample. In practice, this can understate expected loss, weaken pricing and limit decisions, and create model risk. The nearest trap is calculating about 2.0%, which is the policy-compliant PD, not the incorrectly reported one asked for in the stem.
Using all 1,000 accounts gives 18/1,000 = 1.8%, and treating unverified outcomes as non-default dilutes the default rate.
Topic: Credit Risk
A bank’s risk team independently challenges the assumptions in a probability-of-default model, checks whether its calibration sample remains representative, and investigates missing borrower data that could bias outputs. Which control function best matches this work?
Best answer: B
What this tests: Credit Risk
Explanation: The work described is independent model validation. It focuses on whether the model’s assumptions, calibration choices and source data are appropriate, because weaknesses in any of these can distort credit-risk metrics such as probability of default.
Model validation is the control function that challenges whether a credit-risk model is fit for purpose. In the stem, the team is not approving loans or monitoring exposures; it is reviewing the model itself. That review covers three common drivers of model risk in credit measurement: assumptions, calibration and data quality. If assumptions are unrealistic, the calibration sample is outdated or unrepresentative, or borrower data are incomplete, measures such as PD and expected loss can be biased. Independent validation helps detect those weaknesses before the model is used for pricing, limits, provisioning or capital decisions.
The closest distractor is stress testing, but stress testing examines performance under adverse scenarios rather than validating whether the core model has been built and fed correctly.
This is model validation because it independently tests whether assumptions, calibration and input data make the credit-risk metric reliable.
Topic: Credit Risk
A bank has the following end-of-day positions. Netting with Bank X is legally enforceable, and collateral can be applied against the net OTC exposure only.
| Activity | Details |
|---|---|
| OTC trades with Bank X | Interest rate swap MTM +£8m; FX forward MTM -£3m; collateral held £4m |
| Investment holding | £10m of Alpha plc senior bonds |
| Fund holding | £10m in a broad UK equity index tracker |
Which option correctly identifies the main exposure in each case?
Best answer: D
What this tests: Credit Risk
Explanation: The OTC exposure to Bank X is first netted across trades and then reduced by collateral, leaving £1m of current counterparty exposure. A holding in one corporate bond is mainly exposed to that issuer’s credit quality, while a broad equity index tracker is mainly exposed to market-wide, or systematic, risk.
The key distinction is between bilateral credit exposure, single-name credit exposure, and market-wide exposure. For the OTC trades, the bank’s current exposure to Bank X is the positive net replacement value after enforceable netting and collateral: £8m - £3m = £5m, then £5m - £4m = £1m. That is counterparty risk because the loss would arise if Bank X defaulted.
The Alpha plc bond holding is mainly issuer risk, since repayment depends on Alpha plc’s ability to meet its obligations. The broad UK equity index tracker is mainly systematic risk, because its value is driven largely by general market movements rather than the default of one named issuer.
The closest trap is to stop at the netted £5m figure and ignore the collateral already held.
Net OTC exposure is £8m minus £3m minus £4m = £1m, and the other two holdings are mainly single-name issuer risk and market-wide systematic risk respectively.
Topic: Credit Risk
A bank’s risk appetite states that no more than 15% of its SME lending may depend on a single end-customer. It has 10 receivables-finance facilities to different wholesalers. Each wholesaler earns over 80% of revenue from the same supermarket chain, and together the facilities equal 22% of the SME portfolio. Which assessment best applies the relevant credit-risk principle?
Best answer: A
What this tests: Credit Risk
Explanation: This is concentration credit risk, not true diversification. Although there are multiple legal borrowers, their repayment capacity is heavily linked to the same supermarket chain, so the bank should assess the exposure on a look-through basis and escalate it because it exceeds the stated risk appetite.
The core concept is credit concentration identified through a common underlying dependency. In receivables finance, separate borrower names do not necessarily create diversification if those borrowers rely on the same source of cash flow. Here, a deterioration in the supermarket chain’s trading position or payment behaviour could weaken several wholesalers at once, creating correlated default risk across the portfolio. Because the bank’s stated appetite caps this type of dependence at 15% and the aggregated exposure is 22%, the correct response is to recognise a hidden concentration, measure it on a look-through basis, and escalate the breach under the risk framework. Stress testing may help assess severity, but it does not replace immediate identification and escalation of a current concentration issue.
Separate facilities do not remove the shared dependence on one supermarket chain, so the exposure should be treated as concentrated credit risk and escalated.
Topic: Credit Risk
A bank’s SME loan book has an average internal PD of 1.4%, unchanged from last quarter. However, 38% of total exposure is now to commercial property developers in one region after rapid growth in that segment. Management is concerned that a local downturn could trigger several related defaults at once. Which concept best explains the main credit-risk issue?
Best answer: B
What this tests: Credit Risk
Explanation: The main issue is concentration risk, not the average default rate. A portfolio can look stable on average but still become materially riskier if many borrowers are exposed to the same economic shock.
This scenario points to concentration risk, which is a core credit-risk measurement and portfolio management concept. The unchanged average PD does not capture the fact that a large share of the book is concentrated in commercial property developers in one region. That means defaults are more likely to be correlated if the local property market weakens, so the portfolio may suffer several losses at the same time.
A sound credit-risk framework therefore looks beyond standalone borrower PDs and considers portfolio diversification, sector and geographic concentrations, and whether exposures remain within risk appetite. The closest distractor is loss given default, but the stem focuses on multiple related defaults occurring together rather than on recovery severity after default.
The key issue is that exposures are clustered in one sector and region, increasing correlated default risk despite an unchanged average PD.
Topic: Credit Risk
A bank’s credit-risk dashboard shows, for each uncleared OTC derivatives trading partner, the current replacement cost and an add-on for potential future exposure until close-out. Which credit exposure type is this metric primarily designed to measure?
Best answer: C
What this tests: Credit Risk
Explanation: Current replacement cost plus potential future exposure is a standard way to assess credit risk on bilateral derivatives. It captures the possibility that the trading partner defaults while the contract still has value to the bank, so the bank must replace it at a loss.
This is a measure of counterparty credit risk. In an uncleared OTC derivatives relationship, the bank is exposed to a specific trading counterparty, and the amount at risk can change over time with market movements. That is why reporting often combines current replacement cost with potential future exposure: it estimates what the bank could lose if the counterparty defaults before the transaction is terminated or replaced.
The closest distractor is issuer exposure, but owning a security and facing a bilateral contract are different credit relationships.
It measures the loss that could arise if the derivatives trading partner defaults before the contracts are closed out, which is counterparty rather than issuer exposure.
Topic: Credit Risk
A bank’s treasury desk holds £25 million of senior unsecured bonds issued by Delta Utilities. It also has an OTC interest-rate swap with Oak Bank that currently has a positive mark-to-market of £3 million to the bank. Because of a documentation gap, no collateral has been exchanged, and Oak Bank has missed its latest margin call. Which position should be reported as counterparty exposure rather than issuer exposure?
Best answer: A
What this tests: Credit Risk
Explanation: The swap creates exposure to Oak Bank as the contractual trading counterparty, and the positive mark-to-market means the bank would lose value if Oak Bank fails to perform. The Delta Utilities bond, by contrast, is exposure to the issuer’s ability to pay interest and principal, so it is issuer exposure.
Counterparty exposure arises when a firm is exposed to the non-performance of the other party to a trade, derivative, repo, or settlement arrangement. In this scenario, the OTC swap has a £3 million positive value to the bank, so the bank is relying on Oak Bank to meet its obligations; the missed margin call and lack of collateral reinforce that this is counterparty credit risk. The Delta Utilities bond is different: the bank is exposed to the issuer’s ability to pay coupons and principal on the security, which is issuer exposure. Buying or holding the bond through the treasury desk does not change that classification. The key distinction is whether the exposure comes from the security’s issuer or from the trading relationship itself.
Exposure on the OTC swap depends on Oak Bank performing under the trading contract, so it is counterparty exposure.
Topic: Credit Risk
A bank has a board-approved overall corporate lending limit of £2 billion. The current book is £1.7 billion, but £220 million is to one borrower group, £900 million is to energy companies, £650 million is to offshore drilling firms, and 78% of exposures are in one country. Which action best applies sound concentration-risk management and most supports resilience?
Best answer: A
What this tests: Credit Risk
Explanation: The issue is concentration, not total portfolio size. Separate risk appetite limits across single-name, country, sector and industry exposures improve resilience because one adverse event is less likely to damage a large share of the book at the same time.
Concentration risk arises when exposures are clustered so that losses can be driven by the same underlying shock. In the stem, the portfolio is below its overall size limit, but it is heavily exposed to one borrower group, one country, one sector and one industry. Sound credit risk management therefore applies diversification within risk appetite by setting distinct concentration limits, monitoring them, and escalating when triggers are reached. That allows management to rebalance the book, slow new lending, syndicate exposures or redirect origination before a downturn in one geography or business area creates outsized losses. A total lending cap or average rating can still look acceptable while hidden correlation leaves the bank less resilient.
Separate limits and escalation across these dimensions reduce correlated loss risk and stop one obligor, geography or business area dominating the book.
Topic: Credit Risk
A bank’s exposure to a counterparty increases at the same time as that counterparty’s credit quality deteriorates. Which credit-risk term best describes this?
Best answer: A
What this tests: Credit Risk
Explanation: Wrong-way risk exists when exposure and counterparty credit quality move adversely together. The lender is owed more at exactly the point when the counterparty is weaker and default is more likely.
The core concept is wrong-way risk in counterparty credit risk. It arises when the size of the exposure is positively linked to deterioration in the counterparty’s creditworthiness, so potential loss becomes larger just as default risk increases. This is especially relevant in derivatives and structured transactions where market moves can both increase the mark-to-market exposure and weaken the counterparty’s ability to pay. The key feature is the adverse dependence between exposure and credit quality, not simply the existence of credit exposure on its own. By contrast, settlement risk concerns timing of payment exchange, concentration risk concerns overexposure to a name or sector, and migration risk concerns changes in credit quality such as downgrades.
This is wrong-way risk because exposure rises precisely when the counterparty is becoming more likely to default.
Topic: Credit Risk
A bank has confirmed legal enforceability on a GBP 20 million secured loan to a fund. The fund posts GBP 23 million of thinly traded corporate bonds as collateral, with valuations and margin calls handled manually at end of day. Which approach best applies sound credit risk management?
Best answer: C
What this tests: Credit Risk
Explanation: Collateral can reduce credit exposure, but it does not remove it simply because current market value exceeds the loan amount. Thin trading and manual collateral processes create liquidity and operational complications, so prudent management applies haircuts and stress testing before giving full credit for the security.
The key principle is that collateral only reduces exposure to the extent that it is enforceable, appropriately valued, margined and realistically realisable. In this case, the bonds are thinly traded, so their stressed sale value may be well below the current mark, and manual end-of-day processes increase the risk of delayed or inaccurate valuation and margin calls. A sound approach is therefore to recognise some mitigation benefit, but only after conservative haircuts and stress testing of how quickly the bank could value, seize and liquidate the bonds if the fund defaulted. Treating the position as mainly market risk misses that this is still a secured credit exposure, and treating over-collateralisation or legal enforceability as sufficient ignores gap, liquidity and process risk.
Collateral reduces exposure only to the extent it can be valued, controlled and liquidated reliably, especially in stressed conditions.
Use the CISI Risk Practice Test page for the full Securities Prep route, mixed-topic practice, timed mock exams, explanations, and web/mobile app access.
Read the CISI Risk guide on SecuritiesMastery.com, then return to Securities Prep for timed practice.