FRM Part II · FRM Exam Part II · Credit Risk
A bank holds a term loan with an exposure at default of USD 8,000,000, a one-year probability of default of 2.5%, and a loss given default of 40%. What is the one-year expected loss?
Expected loss is PD times LGD times EAD, which is 2.5% x 40% x USD 8,000,000 = USD 80,000. Omitting the loss given default gives USD 200,000, and omitting the default probability gives USD 320,000; both are incorrect.
- AUSD 80,000Correct
- BUSD 200,000
- CUSD 320,000
- DUSD 800,000
Explanation
Expected loss = PD x LGD x EAD = 0.025 x 0.40 x 8,000,000 = 80,000. USD 200,000 results from omitting LGD (0.025 x 8,000,000). USD 320,000 uses 1 - PD style confusion with LGD of 40% applied to EAD only (0.40 x 8,000,000), ignoring PD.
Did you get it right without looking?
One question tells you little. A timed set on Credit Risk shows your real accuracy, how long you take and where you lose marks.
More Credit Risk questions
- A risk manager notes that in a Merton-type model, short-term credit spreads for a highly rated firm with no near-term debt maturity approach…
- In the Basel IRB formula, the capital requirement K is intended to cover which portion of credit losses at a 99.9% confidence level over one…
- A bank has a single uncollateralized over-the-counter derivative with a corporate counterparty. The contract currently has a mark-to-market …
- A bank holds two uncorrelated-default loans in a simplified setting, each with EAD of USD 10 million, LGD of 100%, and PD of 2%. Treating ea…
- A bank wants to reduce regulatory capital on a loan portfolio and reduce funding needs, and sells the loans to a special purpose vehicle tha…
- A credit analyst compares two approaches to modeling default of a listed manufacturing firm. Approach A models default as the point at which…