Risk Management interview preparation

Questions

100

Traced to a firm

37

Firms

12

Updated

September 2026

Asked at

All firmsUBS14MSCI7BLBlackRock5FTFranklin Templeton3Oaktree Capital Management2Scotiabank2Jane Street1Moody's1Neuberger Berman1PIMCO1SSState Street1TSTruist Securities1

Topic

All topicsMarket risk and VaR14Tail risk and stress testing5Greeks and sensitivities5Credit risk11Counterparty risk and CVA6Operational risk5Model risk and validation6Regulatory capital7Liquidity risk and ALM6Statistics and quant foundations7Indian regulation7Risk governance and appetite4Markets and macro9Fit and career8

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Type

AnyTechnicalCaseBrainteaserMarket viewFit

1. 025Explain PD, LGD and EAD.Credit riskCorephone / first roundBank credit riskRating agencies

   Say this

   They're the three inputs to expected loss. Probability of default is how likely the borrower stops paying, loss given default is the fraction you don't recover, and exposure at default is how much is outstanding when it happens. Multiply the three and you have expected loss.

   Then walk it

   1. PD is a probability over a horizon, usually one year, and it comes from a rating or a scorecard. Say the horizon, because a one-year PD and a lifetime PD are very different numbers.
   2. LGD is one minus the recovery rate, expressed on the exposure. It's driven by collateral, seniority and how good the legal enforcement regime is. Senior secured on a warehouse in a good jurisdiction might be 25 percent; unsecured sub debt is 70 to 90.
   3. EAD is what's actually outstanding at default. For a term loan it's roughly the drawn balance. For a revolver or a credit card it's the drawn amount plus a credit conversion factor on the undrawn part, because stressed borrowers draw their lines down before they default.
   4. Worked number: a 100 crore facility, PD of 2 percent, LGD of 40 percent gives expected loss of 0.8 crore, so 80 basis points. That's a provisioning and pricing number, not a capital number.
   5. The three are not independent, and that's the bit people miss. In a recession PD rises and recoveries fall at the same time, because collateral values are down and everyone is selling. That's downturn LGD, and Basel requires you to use it rather than a long-run average.
   6. For a derivative there's no drawn balance, so EAD has to be modelled from potential future exposure. That's a different exercise entirely, and it's why counterparty credit risk has its own framework.

   Where candidates lose it

   Getting the definitions right and missing that PD and LGD are correlated. Using an average recovery rate through a downturn understates loss badly, and downturn LGD is a specific Basel requirement. Also state the PD horizon; a PD without a horizon is not a number.

   Expect next

   • Why does Basel require downturn LGD?
   • How do you estimate EAD on a revolver?
   • How would you estimate PD for a borrower with no rating?
2. 026What's the difference between expected and unexpected loss, and which one does capital cover?Credit riskCoretechnicalBank credit riskRegulatory reporting

   Say this

   Expected loss is the average you lose in a normal year, and it's covered by provisions and priced into the loan spread. Unexpected loss is the deviation above that in a bad year, and that's what capital is for. Provisions cover the mean, capital covers the tail.

   Then walk it

   1. Expected loss is PD times LGD times EAD. It's a cost of doing business, so it belongs in the price. If your spread doesn't cover EL plus funding plus operating cost plus a return on capital, you're lending at a loss.
   2. Unexpected loss is the distance from the mean to a high quantile of the loss distribution, usually 99.9 percent over one year in Basel's IRB framework. That's the one-in-a-thousand-year bad year the bank is supposed to survive.
   3. The distribution is heavily right-skewed, not normal, because defaults are correlated. Most years you lose a little, occasionally you lose a lot, and the asymmetry is driven entirely by that correlation.
   4. The mechanism is the asset correlation assumption. If defaults were independent, a large portfolio would have almost no unexpected loss and you'd need almost no capital. Basel's IRB formula bakes in correlations of roughly 12 to 24 percent for corporates, and it's that number, not PD, that creates the capital requirement.
   5. Numerical feel: a portfolio with 80 basis points of expected loss might carry a 99.9 percent loss of 5 or 6 percent. So capital is several times provisions, and that ratio widens for a concentrated book.
   6. The gap that matters in practice: IFRS 9 provisions and Basel expected loss are computed differently, so the two rarely agree, and the shortfall or excess adjusts CET1. That reconciliation is a real job in a bank's finance and risk function.

   Where candidates lose it

   Saying capital covers expected loss. It doesn't, provisions do, and mixing those up is a hard fail in a credit risk interview. The answer that stands out names asset correlation as the thing generating unexpected loss, because a candidate who says that understands why a diversified book still needs capital.

   Expect next

   • Why is the loss distribution skewed?
   • What drives the size of unexpected loss more, PD or correlation?
   • How does the IFRS 9 provision interact with regulatory capital?
3. 029What is the difference between a point-in-time and a through-the-cycle rating, and when does it matter?Credit riskIntermediatetechnicalBank credit riskRating agencies

   Say this

   A point-in-time PD reflects the borrower's risk right now, including where we are in the cycle. A through-the-cycle rating strips the cycle out and asks how the borrower would do on average across one. PIT moves a lot, TTC barely moves.

   Then walk it

   1. Agency ratings are broadly through-the-cycle by design. That's why an investment grade issuer doesn't get downgraded every recession, and why agencies talk about rating through a trough.
   2. IFRS 9 needs point-in-time, because expected credit loss is supposed to be a current, forward-looking estimate conditioned on today's macro forecast.
   3. Basel IRB regulatory capital leans through-the-cycle, deliberately, to stop capital requirements swinging with the cycle. If PDs were fully PIT, RWAs would balloon in a recession precisely when banks can't raise capital.
   4. That's the procyclicality argument and it's the real content of this question. A PIT capital regime amplifies the cycle: losses rise, RWAs rise, capital ratios fall twice over, lending contracts, the recession deepens.
   5. The practical consequence is that a bank runs two PD scales and a mapping between them, and the conversion is genuinely hard. You need a macro model to shift a TTC PD to a PIT PD for a given scenario.
   6. The honest caveat: no real rating system is purely one or the other. Agency ratings do migrate in downturns, and IRB models do have cyclical components. It's a spectrum, and the useful question about any model is how much of the cycle it passes through.

   Where candidates lose it

   Defining both and not explaining why anyone cares. The payoff is procyclicality: why regulators want TTC for capital and accountants want PIT for provisions, and why the same borrower carries two different PDs in the same bank on the same day.

   Expect next

   • Which does IFRS 9 need, and why?
   • How would you convert a TTC PD to a PIT PD?
   • Is procyclicality a real problem or a theoretical one?
4. 030Explain IFRS 9 expected credit loss staging.Credit riskIntermediatetechnicalBank credit riskRegulatory reporting

   Say this

   Three stages. Stage 1 is performing, and you provide twelve-month expected loss. Stage 2 is a significant increase in credit risk since origination, and you jump to lifetime expected loss. Stage 3 is credit impaired, lifetime loss with interest recognised on the net carrying amount.

   Then walk it

   1. The whole model is forward-looking and unbiased, probability-weighted across at least a couple of macro scenarios. That's the break from the old incurred-loss model, which waited for evidence of impairment before providing.
   2. The cliff is the interesting bit. Moving from Stage 1 to Stage 2 changes the horizon from twelve months to lifetime, so on a twenty-year mortgage the provision can jump by a multiple overnight without a single missed payment.
   3. The trigger for Stage 2 is a significant increase in credit risk, judged on relative change in lifetime PD since origination, not an absolute level. There's a 30-days-past-due backstop presumption and a low credit risk exemption.
   4. Stage 3 is default, aligned in most banks to the 90-day past due and unlikely-to-pay definitions. Interest revenue then accrues on the carrying amount net of the provision, which is the effective-interest change people forget.
   5. Practical machinery: you need lifetime PD curves, LGD, EAD profiles, discounting at the effective interest rate, and macro scenario weights. Then a management overlay, because in 2020 every model built on pre-pandemic data produced numbers nobody believed.
   6. The criticism to volunteer: the Stage 2 cliff makes provisions lumpy and procyclical, and the scenario weights are a judgement that moves the P&L by a lot. Two banks with identical books can report materially different provisions, which is exactly what IFRS 9 was supposed to reduce.

   Where candidates lose it

   Getting the stages right and missing the twelve-month versus lifetime switch, which is the whole economic content. Also don't call Stage 2 'past due'. It's a relative deterioration in credit risk; 30 days past due is only a backstop.

   Expect next

   • Why is the Stage 2 transition criticised?
   • How do you set macro scenario weights?
   • How does this differ from Basel expected loss?
5. 031How does IFRS 9 expected credit loss differ from Basel regulatory expected loss?Credit riskHardsuperdayBank credit riskRegulatory reporting

   Say this

   Different purposes, so different parameters. IFRS 9 is accounting: point-in-time, forward-looking, neutral, and lifetime for Stage 2 and 3. Basel is prudential: through-the-cycle PD, downturn LGD, twelve-month horizon, and deliberately conservative.

   Then walk it

   1. Horizon. Basel EL is always twelve months. IFRS 9 is twelve months in Stage 1 and lifetime in Stages 2 and 3.
   2. PD. Basel wants a long-run average, through-the-cycle PD. IFRS 9 wants a point-in-time PD conditioned on a macro forecast.
   3. LGD. Basel requires downturn LGD, a stressed recovery assumption. IFRS 9 wants a neutral, expected LGD with no prudential margin.
   4. Discounting. IFRS 9 discounts cash shortfalls at the effective interest rate. Basel EL is undiscounted.
   5. Then the reconciliation, which is where real work happens. For IRB banks, if accounting provisions exceed Basel EL, the excess counts in Tier 2 up to a cap of 0.6 percent of credit RWA. If provisions fall short, the shortfall is deducted straight from CET1. So the two frameworks meet in the capital ratio.
   6. For standardised-approach banks it's different again: general provisions can count in Tier 2 up to 1.25 percent of credit RWA, and specific provisions reduce the exposure value.
   7. And the transitional arrangements matter historically. When IFRS 9 came in, supervisors allowed a phase-in of the day-one CET1 hit precisely because the provision increase was large enough to be destabilising.

   Where candidates lose it

   Treating them as the same number with different labels. Naming the four parameter differences is table stakes; the answer that lands explains the CET1 shortfall deduction and the Tier 2 excess cap, because that's the bit that actually affects a bank's capital ratio.

   Expect next

   • What happens to CET1 if provisions are below Basel EL?
   • Why is Basel LGD downturn and IFRS 9 LGD neutral?
   • Which framework produced a bigger provision in 2020?
6. 034Describe what distressed debt is.Credit riskIntermediatetechnicalOaktree Capital ManagementRisk · Los Angeles · 2022

   Say this

   Debt of a company in or near financial distress, trading at a deep discount, usually quoted in cents on the dollar rather than on a yield. The convention is a spread over 1,000 basis points or a price under 70, and the analysis shifts from yield to recovery.

   Then walk it

   1. The mental switch is the key point. For performing credit you underwrite the probability of getting paid the coupon. For distressed you underwrite what the asset is worth in a restructuring and where in the capital structure you sit when it's divided up.
   2. So the work is a valuation exercise plus a legal one. Build an enterprise value under a restructured plan, then walk the waterfall: secured, then unsecured, then sub debt, then equity. The fulcrum security is the one where value runs out, and owning it is how you end up controlling the reorganised equity.
   3. Two strategies, and they're different businesses. Passive: buy mispriced paper and wait. Active or loan-to-own: buy the fulcrum, lead the creditor committee, negotiate the plan, convert to equity.
   4. Risk factors specific to it: process risk, because the outcome depends on a court and on other creditors, not just on the business. Duration risk, because restructurings take years. Illiquidity. And documentation risk, since covenant and intercreditor terms often matter more than the financials.
   5. From a risk-management seat in a distressed fund, the hard problems are valuation of assets with no observable price, position concentration, the fact that VaR is meaningless on paper that doesn't trade, and side-pocket or gate mechanics if investors want out.
   6. The Indian dimension is worth a line: the Insolvency and Bankruptcy Code created a real distressed market after 2016, with ARCs and stressed-asset funds buying from banks. Average haircuts through the IBC have been steep and resolution timelines have run well past the statutory 330 days, which is exactly the process risk you're underwriting.

   Where candidates lose it

   Defining it by price alone and never mentioning the fulcrum security or the capital structure waterfall. Distressed investing is a legal and structural discipline as much as a financial one, and a candidate who can't say what a fulcrum security is has read a definition, not a deal.

   Expect next

   • What is the fulcrum security and why do you want it?
   • How would you value a company in bankruptcy?
   • How would you risk-manage a portfolio of illiquid distressed positions?

   Reported by candidates at Oaktree Capital Management (Risk, Los Angeles, 2022). Source: Wall Street Oasis.

7. 035Explain the Merton model, and the difference between structural and reduced-form credit models.Credit riskHardtechnicalBank credit riskModel validation

   Say this

   Merton treats equity as a call option on the firm's assets with a strike equal to its debt. Default happens when asset value falls below debt at maturity, so you can back out a default probability from the equity price and its volatility. That's the structural family; reduced-form models skip the story and fit default intensity straight from market spreads.

   Then walk it

   1. The Merton set-up: firm assets follow a lognormal process, equity holders own a call with strike equal to the debt face value, and default probability is the chance the asset value ends below that strike. Distance to default is how many asset standard deviations you are above the barrier.
   2. The clever part is that it's forward-looking and uses market data. Equity prices update every second, so a structural PD reacts long before a rating agency does. That's what Moody's KMV commercialised as EDF.
   3. Its weaknesses are specific. It underpredicts short-term default because the asset process is continuous and can't jump. It needs asset value and asset volatility, neither of which is observable. It assumes one debt maturity. And it produces credit spreads well below observed ones, the credit spread puzzle.
   4. Reduced-form, or intensity models like Jarrow-Turnbull and Duffie-Singleton, take default as an exogenous Poisson-type event with a hazard rate calibrated from CDS or bond spreads. No story about why the firm defaults, just a fit to prices.
   5. So the trade-off: structural models explain and give you economic intuition and a link to the equity market. Reduced-form models fit market prices and are what you use to value and hedge credit derivatives.
   6. In practice a bank uses both and for different jobs. Structural or hybrid models for wholesale PD estimation and early warning; reduced-form for pricing and for CVA. And the risk-management caveat: a structural model's PD spikes whenever equity vol spikes, so it's cyclical and noisy, which is fine as an early warning signal and bad as a provisioning input.

   Where candidates lose it

   Describing equity as a call option and stopping. The interviewer will ask what's wrong with Merton, and 'it underpredicts short-horizon default because assets can't jump' plus 'asset value and asset volatility aren't observable' are the answers. Also be able to say which model you'd use for pricing versus for PD estimation.

   Expect next

   • What is distance to default?
   • Why does Merton understate short-term default risk?
   • Which would you use to price a CDS?

Firm tags come from public, anonymous candidate reports on Wall Street Oasis: strong signal, not sworn testimony. Firms are named as the places a question was reported, not as partners of Fin Maverick. Answers are written for this page to show how to think out loud; they are not scripts to recite.