FRM Part II · FRM Exam Part II · Credit Risk
A bank holds a term loan with exposure at default of USD 20 million, 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 equals exposure at default times probability of default times loss given default: 20 million x 2.5% x 40% = USD 200,000. Ignoring loss given default would overstate the figure at USD 500,000.
- AUSD 200,000Correct
- BUSD 500,000
- CUSD 8.0 million
- DUSD 300,000
Explanation
Expected loss = EAD x PD x LGD = 20,000,000 x 0.025 x 0.40 = 200,000. USD 500,000 ignores LGD (EAD x PD). USD 8.0 million is EAD x LGD with no PD.
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