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FRM Part II · FRM Exam Part II · Risk Measurement and Assessment

A bank's loss distribution approach models annual loss frequency as Poisson with mean 20 events per year and severity with mean USD 50,000. Assuming independence of frequency and severity, what is the expected annual aggregate loss?

Expected annual aggregate loss equals expected frequency times expected severity, 20 times USD 50,000, which is USD 1,000,000. This holds when frequency and severity are independent. Using severity alone ignores how many events occur in a year.

  1. AUSD 50,000
  2. BUSD 400,000
  3. CUSD 1,000,000Correct
  4. DUSD 2,500

Explanation

Expected aggregate loss = E[N] x E[X] = 20 x 50,000 = USD 1,000,000. USD 50,000 ignores frequency, and USD 2,500 divides instead of multiplying. USD 400,000 has no valid basis (it is not a product of the given data).

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