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CMA Final · Risk Management in Banking and Insurance · Sovereign Risk and Insolvency Risk

A bank holds a foreign sovereign bond with an exposure of Rs 200 crore. The assessed probability of default is 2% and the expected loss given default is 45%. What is the expected loss on this exposure?

Expected loss is Rs 1.8 crore. It equals exposure times probability of default times loss given default: 200 crore x 2% x 45%. Ignoring loss given default gives Rs 4 crore, which overstates the loss because recoveries are not accounted for.

  1. ARs 1.8 croreCorrect
  2. BRs 4.0 crore
  3. CRs 0.9 crore
  4. DRs 90.0 crore

Explanation

Expected loss = exposure x PD x LGD = 200 x 0.02 x 0.45 = Rs 1.8 crore. Rs 4.0 crore ignores LGD (200 x 0.02). Rs 90 crore ignores PD (200 x 0.45). Rs 0.9 crore uses a 1% PD, which is wrong.

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