FRM Part II · FRM Exam Part II · Credit Value at Risk
A bank's credit risk team computes expected loss on a corporate term loan using the standard decomposition. Which expression correctly gives the expected loss for a single exposure?
Expected loss for a single exposure is PD multiplied by LGD multiplied by EAD. It combines the likelihood of default, the fraction lost after recoveries, and the amount outstanding at default. Replacing LGD with one minus LGD would give recovery, not loss.
- APD × LGD × EADCorrect
- BPD × (1 − LGD) × EAD
- CLGD × EAD ÷ PD
- D(1 − PD) × LGD × EAD
Explanation
Expected loss equals the probability of default times the loss given default (as a fraction of exposure) times the exposure at default. Using (1 − LGD) gives the expected recovery, not the loss. Using (1 − PD) gives the survival probability instead of default probability.
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