Estimating Default Probabilities (FRM Part 2 - Book 2 - Credit Risk - Ch 9)

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After completing this reading, you should be able to:
- Compare agencies’ ratings to internal credit rating systems.
- Describe linear discriminant analysis (LDA), define the Altman’s Z-score and its usage, and apply LDA to classify a sample of firms by credit quality.
- Describe the relationship between borrower rating and probability of default.
- Describe a rating migration matrix and calculate the probability of default, cumulative probability of default, and marginal probability of default.
- Define the hazard rate and use it to define probability functions for default time as well as to calculate conditional and unconditional default probabilities.
- Describe recovery rates and their dependencies on default rates.
- Define a credit default swap (CDS) and explain its mechanics including the obligations of both the default protection buyer and the default protection seller.
- Describe CDS spreads and explain how CDS spreads can be used to estimate hazard rates.
- Define and explain CDS-bond basis.
- Compare default probabilities calculated from historical data with those calculated from credit yield spreads.
- Describe the difference between real-world and risk-neutral default probabilities and determine which one to use in the analysis of credit risk.
- Using the Merton model, calculate the value of a firm’s debt and equity, the volatility of firm value, and the volatility of firm equity.
- Using the Merton model, calculate distance to default and default probability.
- Assess the quality of the default probabilities produced by the Merton model, the Moody’s KMV model, and the Kamakura model.

[@hannaotr]

Isn't there a mistake on the slide regarding the dependance between RR and PD? I think the axis are incorrectly signed, we should habe RR on the Y axis and PD on X axis, then the comments make sense