FRM Part I · FRM Exam Part I · Measuring Credit Risk
A bank lends USD 20 million to a firm and holds collateral currently worth USD 12 million after any haircut. Assume the exposure at default is USD 20 million, the collateral value at default is unchanged, and the unsecured portion has a recovery rate of 25%. The probability of default is 3%. What is the expected loss?
Expected loss is USD 180,000. Collateral of USD 12 million covers part of the USD 20 million exposure, leaving USD 8 million unsecured. With 25% recovery on that, the loss is USD 6 million, and multiplying by the 3% default probability gives USD 180,000.
- AUSD 90,000Correct
- BUSD 120,000
- CUSD 180,000
- DUSD 270,000
Explanation
Unsecured portion = 20 - 12 = USD 8 million. Loss on it = 8 x (1 - 0.25) = USD 6 million. EL = 0.03 x 6,000,000 = USD 180,000. Wait: this equals 180,000, so recheck options: the correct figure is USD 180,000.
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