FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management
A bank estimates that a loan portfolio has a one-year expected loss of USD 12 million. Over the same horizon, the 99.9% credit loss quantile is USD 87 million. Using the common economic capital definition, how much economic capital should be held for this portfolio?
Economic capital is USD 75 million. It equals the 99.9% loss quantile of USD 87 million minus the expected loss of USD 12 million, because expected loss is absorbed by pricing and provisions, leaving only unexpected loss to be covered by capital.
- AUSD 75 millionCorrect
- BUSD 87 million
- CUSD 99 million
- DUSD 12 million
Explanation
Economic capital covers unexpected loss, defined as the loss quantile minus expected loss: 87 - 12 = 75 million. Holding 87 million would ignore that expected loss is covered by pricing and provisions. Adding gives 99, which has the wrong sign.
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