FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment
A bank lends USD 2,000,000 to a corporate borrower. The one-year probability of default is 2%, the loss given default is 45%, and the exposure at default equals the full amount. What is the one-year expected loss?
The expected loss is USD 18,000, found by multiplying PD of 2%, LGD of 45% and EAD of USD 2,000,000. Omitting LGD would give USD 40,000, which overstates the loss because some value is recovered after default.
- AUSD 18,000Correct
- BUSD 40,000
- CUSD 900,000
- DUSD 1,100,000
Explanation
Expected loss = PD × LGD × EAD = 0.02 × 0.45 × 2,000,000 = 18,000. USD 40,000 ignores LGD and treats the whole exposure as lost on default. The other two figures are not products of the three components.
Did you get it right without looking?
One question tells you little. A timed set on Introduction to Credit Risk Modeling and Assessment shows your real accuracy, how long you take and where you lose marks.
More Introduction to Credit Risk Modeling and Assessment questions
- In the KMV implementation of the Merton framework, which default point is conventionally used when computing distance to default?
- A risk analyst compares structural and reduced-form approaches to modeling default. Which statement best describes the reduced-form (intensi…
- Two loans each have EAD of $1 million, constant LGD of 100%, and PD of 10%, so each has a loss standard deviation of $300,000. The default c…
- A firm's equity is observed with volatility of 40%, equity value of 40, and debt of 60 (face value, treated as the default barrier), so asse…
- A risk analyst compares structural (Merton-type) and reduced-form credit models. Which statement correctly describes the reduced-form approa…
- Two loans each have standalone unexpected loss of $4 million. The default correlation between them is 0.25. Using the standard formula for t…