FRM Part II · FRM Exam Part II · Credit Risk Management
A bank wants to decide how much capital to allocate to a single new loan within an existing portfolio, reflecting the loan's contribution to the portfolio's overall risk. Which measure is most appropriate?
The risk contribution of the loan is most appropriate. It measures the loan's share of portfolio unexpected loss after reflecting its correlation with other exposures, and contributions sum to total portfolio risk, so capital is allocated consistently, unlike stand-alone risk that ignores diversification.
- AThe loan's stand-alone unexpected loss
- BThe loan's expected loss only
- CThe loan's risk contribution, which accounts for its correlation with the rest of the portfolioCorrect
- DThe loan's notional divided by total portfolio notional
Explanation
Stand-alone risk ignores diversification, while risk contribution captures the loan's marginal effect on portfolio unexpected loss given its correlation with other exposures. Contributions sum to total portfolio risk, supporting consistent capital allocation. Expected loss is covered by provisions or pricing rather than capital.
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