FRM Part II · FRM Exam Part II · Credit Risk
A bank wants to identify which obligor in its portfolio contributes most to total portfolio credit risk, allowing for diversification. Which measure is most appropriate?
The best measure is the obligor's risk contribution, meaning its marginal contribution to portfolio loss volatility or VaR. It accounts for exposure, default probability, loss given default and correlation with other obligors, and contributions sum to total portfolio risk. Expected loss, exposure share or rating ignore diversification effects.
- AThe obligor's stand-alone expected loss
- BThe obligor's risk contribution, the marginal contribution to portfolio loss volatility or VaRCorrect
- CThe obligor's gross exposure as a share of total exposure
- DThe obligor's external credit rating
Explanation
Risk contributions reflect exposure, PD, LGD and correlation with the rest of the portfolio, and they sum to total portfolio risk. Expected loss and exposure ignore correlation, and ratings capture only PD.
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