Problem:
“Throughout the 1990s, as the Credit Monitor was progressively enhanced, the idea of modelling to measure and manage credit risk loan portfolios continued to expand. In the year of 1997, J P Morgan and other firms introduced Credit MetricsTM, also substantially based upon the Merton model and a valuable addition to the field. 1999, Moody’s introduced Risk Calc® as an addition to its traditional ratings technique. In 2002, Moody’s KMV has revised its Risk Calc® model incorporating not only an upgrade of the original model but also incorporating a lot of the research and techniques of the KMV Private Firm Model”.
(Measuring Default Risk and Credit Risk Management)
Required:
Question 1: With the use of diagrams, illustrate out how Moody’s KMV Credit Monitor computes the Expected Default Frequency (EDF) or Probability of Default (PD).
Question 2: Illustrate out to what extent Z-Score and the Zeta models are still valuable in modern Credit risk management.