Ace the 2026 GARP FRM Part 1 Challenge – Master Financial Risks Like a Pro!

The three main types of credit risk include default risk, concentration risk, and migration risk, making this the correct answer.

Default risk refers to the probability that a borrower will be unable to meet their contractual obligations, such as failing to make principal or interest payments. It is the most fundamental component of credit risk since it directly impacts the lender's potential losses.

Concentration risk arises when a financial institution has a significant portion of its total credit exposure in a single borrower or a group of borrowers with similar characteristics. This type of risk can lead to greater losses if the highly concentrated positions experience defaults, as the impact is magnified.

Migration risk, on the other hand, pertains to the potential changes in the credit quality of borrowers or securities that can lead to a downgrade in ratings. This affects the overall portfolio's value and loss expectation, as borrowers may move into lower credit categories, increasing the likelihood of default.

Understanding these aspects of credit risk is crucial for financial institutions to manage their portfolios effectively and mitigate potential losses. Other options listed do not accurately represent the key types of credit risk. For instance, operational and market risks relate to broader financial risks not limited to the credit aspect, while equity and interest rate risks pertain to different types of financial exposures