Credit Risk Measurement Methodologies

Very Hard Credit Analysis And Valuation Credit Risk Measurement

In the analysis of credit risk, two institutional investors are evaluating a corporate bond with the following characteristics: a credit rating of BB, a current yield of 6%, and a duration of 5 years. Investor A is assessing the bond's exposure to credit risk using the Merton model, which incorporates asset value volatility and default probabilities, while Investor B is using a simpler approach based on historical default rates in similar rating categories over the last economic cycle.

Given these two approaches, which statement best explains the difference in how each investor measures credit risk?

Investor A's method accounts for market conditions and future projections, whereas Investor B's method is limited to retrospective analysis.

Investor A focuses solely on quantitative metrics, while Investor B integrates qualitative factors affecting the issuer's creditworthiness.

Investor A relies on empirical data from past defaults, while Investor B uses a theoretical model to assess default probabilities.

Hint

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