FRM Part II · FRM Exam Part II · Credit Risk
A bank's credit portfolio has a one-year expected loss of USD 40 million. The 99.9% one-year credit VaR, measured as the worst-case loss quantile, is USD 310 million. Using the standard definition of economic capital for credit risk, how much economic capital should be allocated to the portfolio?
Economic capital is credit VaR less expected loss, so it equals USD 270 million. Expected losses are absorbed through pricing and provisions, so capital only needs to cover unexpected losses beyond the expected level up to the 99.9% quantile.
- AUSD 270 millionCorrect
- BUSD 310 million
- CUSD 350 million
- DUSD 40 million
Explanation
Economic capital covers unexpected loss, i.e., the quantile loss minus expected loss: 310 - 40 = 270. Using 310 alone ignores that expected loss is covered by provisions and pricing. Adding 40 is a sign error.
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