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FRM Part I · FRM Exam Part I · Operational Risk

A bank's internal loss data for a business line shows 12 loss events in a year, with average severity of USD 0.5 million, and frequency is modeled as Poisson. Management also has external data suggesting that, for peer banks of similar size, annual frequency is 20 events with the same average severity. The risk manager decides to weight internal frequency at 40% and external at 60%. Which is the blended expected annual loss?

The blended expected annual loss is USD 8.4 million. Blended frequency is 0.4 times 12 plus 0.6 times 20, which is 16.8 events a year. Multiplying by the average severity of USD 0.5 million gives 8.4 million.

  1. AUSD 8.4 millionCorrect
  2. BUSD 6.0 million
  3. CUSD 8.0 million
  4. DUSD 16.8 million

Explanation

Blended frequency = 0.4 x 12 + 0.6 x 20 = 4.8 + 12 = 16.8 events. Multiplying by 0.5 million gives USD 8.4 million. USD 16.8 million forgets severity, 6.0 uses internal frequency only, and 8.0 uses the external frequency only.

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