FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management
A bank holds 20,000 identical, small unsecured personal loans, each of 5,000, with a one-year PD of 3% and LGD of 80%. Assume defaults are independent and exposures are at default equal to the balance. What is the expected loss on the portfolio?
Expected loss is 2,400,000. Exposure of 100 million multiplied by a 3% default probability and an 80% loss given default gives 2.4 million. Leaving out LGD would wrongly produce 3 million.
- A2,400,000Correct
- B3,000,000
- C12,000,000
- D80,000,000
Explanation
Total exposure = 20,000 x 5,000 = 100,000,000. EL = 100,000,000 x 3% x 80% = 2,400,000. Omitting LGD gives 3,000,000; taking only LGD gives 80,000,000 as a wrong base.
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