CMA Final · Risk Management in Banking and Insurance · Credit Risk Management
A bank has an exposure at default of ₹40 crore to a manufacturing firm. The one-year probability of default is 2.5% and the loss given default is 45%. The expected loss is:
Expected loss equals probability of default times loss given default times exposure at default. Here that is 2.5% × 45% × ₹40 crore, which gives ₹0.45 crore. Ignoring the loss given default would wrongly give ₹1 crore.
- A₹0.45 croreCorrect
- B₹1.00 crore
- C₹0.18 crore
- D₹18.00 crore
Explanation
Expected loss = PD × LGD × EAD = 0.025 × 0.45 × 40 = ₹0.45 crore. Using PD × EAD only gives ₹1.00 crore, which ignores recoveries. Using LGD × EAD only gives ₹18 crore, which ignores PD.
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