Sept 2019 Q1(iii) equivalent credit ratings and questions!

Hi,

1. Appreciate if someone could confirm that an 'equivalent credit rating' (mentioned in Sept 2019 Q1(iii), copied below*) simply refers to an internal FAM view of what a credit rating should be, in contrast to an external credit rating agency. [This exam isn't included in latest ASET and haven't seen this term before]

2. If so, this appears to significantly overlap with part (i) of the same question (also copied below*), about the filtering stage identifying suitable investments. Both have similar command verbs ((i) List which factors..should consider vs (iii) State the factors..should consider) but Examiners Report solutions are markedly different [eg. part (i) is simple concepts like size, currency while part (ii) expected to include caveats, consideration of alternatives like portfolio comparison]. Any idea why?

3. What is the best approach when faced with two question parts in one paper which appear overlapping- duplicate my answers to both in my script but ensure add a few specific bullets tailored to each question part? Or there is usually cross-marking between question parts and so no point in duplicating points between question parts. [Some solutions to parts (i) and (iii) also appear relevant to part (vii) of same question, also copied below.]

*FAM is active in both buying bonds at the point of issuance and buying and selling bonds in the secondary market. It broadly follows a two-stage process: • Filter the bond universe down to an investable universe, that is, the bonds that FAM would invest in (“Filtering Stage”). • Construct an investment portfolio using bonds in the investable universe (“Portfolio Construction Stage”).
(i) List which factors FAM should consider in the Filtering Stage. [9]...

To communicate more effectively to prospective investors, a risk actuary is hired by FAM to derive equivalent credit ratings for its largest holdings by market value, allowing for the default experience of corporate bonds of different ratings.
(iii) State the factors the actuary should consider when deriving the equivalent credit ratings. [6]..
(vii) Describe the factors an insurer would consider to help it decide whether to enter into a reinsurance arrangement with FAM. [6]

 

thanks Alvin for the fast and helpful response (looking forward to my next weekend spent without any exam study and hopefully you can take a break from forum duties )

I was confused about the benefit in FAM determining its own rating when the external credit rating agency would have already analysed the default experience of the issuer. But now appreciate that exam is discussing an actuary estimating a rating for a catastrophe bond using an external rating for a corporate bond as one input. (And the catastrophe bond/SPV's unique characteristics, default experience etc will be other inputs.)

Follow-up Q: Examiners report (for this question part (iii)) says: "perhaps it’s more sensible to compare a portfolio of cat bonds to a portfolio of corporate bonds, rather than on an individual basis" Why is this true, especially as we're discussing the largest individual cat bonds?