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CMA Final · Risk Management in Banking and Insurance · Credit Risk Management

A bank has an exposure at default of ₹80 lakh to a borrower with a one-year probability of default of 2.5% and loss given default of 40%. The expected loss is:

Expected loss equals probability of default times loss given default times exposure at default: 2.5% × 40% × ₹80 lakh gives ₹0.80 lakh. Ignoring the loss given default would overstate the loss at ₹2 lakh.

  1. A₹0.80 lakhCorrect
  2. B₹2.00 lakh
  3. C₹32.00 lakh
  4. D₹0.50 lakh

Explanation

Expected loss = PD × LGD × EAD = 0.025 × 0.40 × 80 lakh = 0.80 lakh. Omitting LGD gives ₹2.00 lakh, which wrongly assumes a full loss on default.

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