Which are two common methods for measuring credit risk?

The selection of credit risk models and credit ratings from agencies as methods for measuring credit risk is accurate due to their established frameworks and widespread use in the industry. Credit ratings provided by agencies like Moody’s and Standard & Poor’s give investors and lenders an insight into the creditworthiness of borrowers or securities, reflecting the likelihood of default based on a range of factors, including financial health and economic conditions. These ratings simplify the assessment of credit risk by offering a standardized measure that can be compared across different entities and instruments.

Credit risk models, on the other hand, leverage quantitative techniques and historical data to estimate the probability of default and potential loss. These models may include structural approaches, such as those incorporating firm value, as well as reduced-form models, which often focus on observable market data. By utilizing these models, financial institutions can derive a quantitative measure of credit risk that is tailored to specific portfolios or instruments.

Other approaches mentioned, such as cash flow analysis and financial ratios, play a role in evaluating credit risk but tend to be less comprehensive as standalone methods compared to credit ratings and credit risk models. Cash flow analysis focuses on a borrower's ability to generate sufficient cash flows to meet its debt obligations, while financial ratios measure various aspects of financial health but may not effectively