FRM Part II · FRM Exam Part II · Fundamentals of Credit Risk
A bank grants a revolving credit line with a limit of USD 20 million, of which USD 8 million is drawn. The bank estimates a credit conversion factor of 50% on the undrawn portion at default, a one-year PD of 4%, and an LGD of 40%. What is the one-year expected loss?
EAD is the drawn USD 8 million plus 50% of the USD 12 million undrawn, giving USD 14 million. Expected loss is 4% x 40% x USD 14 million = USD 224,000. Using only the drawn balance understates exposure.
- AUSD 128,000
- BUSD 192,000Correct
- CUSD 320,000
- DUSD 224,000
Explanation
EAD = 8 + 0.5 x 12 = USD 14 million. EL = 0.04 x 0.40 x 14,000,000 = USD 224,000. Check: 14m x 0.016 = 224,000. The USD 128,000 option uses only the drawn amount; USD 192,000 would use EAD of 12m (undrawn only).
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