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FRM Part I · FRM Exam Part I · External and Internal Credit Ratings

A bank has two grades whose one-year PIT PDs in the current downturn are 4% for grade 5 and 8% for grade 6. A TTC system assigns the same borrowers to grades with long-run average PDs of 2% (grade 5) and 5% (grade 6). A loan portfolio of USD 200 million is split equally between the two grades, LGD is 50%, and exposure is fixed. What is the difference between expected loss under the PIT PDs and under the TTC PDs (PIT minus TTC)?

Expected loss under PIT PDs is USD 6.0 million (2 + 4), while under TTC PDs it is USD 3.5 million (1 + 2.5), using USD 100 million per grade and 50% LGD. The difference is USD 2.50 million, showing TTC understates downturn loss.

  1. AUSD 2.50 millionCorrect
  2. BUSD 1.25 million
  3. CUSD 5.00 million
  4. DUSD 3.75 million

Explanation

Each grade has USD 100 million. PIT EL = 100×0.04×0.5 + 100×0.08×0.5 = 2 + 4 = 6.0 million. TTC EL = 100×0.02×0.5 + 100×0.05×0.5 = 1 + 2.5 = 3.5 million. Difference = 2.5 million. Forgetting LGD would give 5.0 million; using a half-portfolio base gives 1.25 million.

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