Consider the Following Hypothetical Transition Matrix: Which of the Following

question 61

Multiple Choice

Consider the following hypothetical transition matrix: Which of the following statements is true?

• A)A borrower with a risk grade of 2 at the beginning of the year has a 3% probability of being downgraded to a risk grade of 3.
• B)A borrower with a risk grade of 3 at the beginning of the year has a 0.04% probability of being upgraded to a risk grade of 1.
• C)A borrower with a risk grade of 2 at the beginning of the year has a 12% probability of being downgraded to a risk grade of 1.
• D)A borrower with a risk grade of 2 at the beginning of the year has an 85% probability of being upgraded to a risk grade of 1.

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Definitions:

Nominal Interest Rates

are the stated interest rates on financial products or loans, not adjusted for inflation, indicating the actual rate of interest charged by lenders.

Real Interest Rates

The interest rate adjusted for inflation, reflecting the real cost of borrowing and the true return on savings.

Tax-exempt Interest Payments

Interest income that is not subject to federal income tax.

Riskier Loans

Loans that have a higher chance of default, often associated with higher interest rates to compensate for the increased risk.