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FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management

A bank's retail portfolio has an expected default rate of 2% in normal conditions. Using a one-factor Gaussian copula framework, the 99.9% worst-case default rate is 9%. The portfolio has 10,000 loans of 10,000 each, LGD is 50%. Unexpected loss at the 99.9% level, defined as worst-case loss less expected loss, is closest to:

Unexpected loss is about 3.5 million. Worst-case loss is 100 million times 9% times 50%, or 4.5 million; expected loss is 1.0 million; the difference is 3.5 million. Reporting 4.5 million would forget to deduct expected loss.

  1. A3,500,000Correct
  2. B4,500,000
  3. C7,000,000
  4. D9,000,000

Explanation

Exposure = 100,000,000. Worst-case loss = 100m x 9% x 50% = 4.5m. EL = 100m x 2% x 50% = 1.0m. UL = 3.5m. Choosing 4.5m ignores subtracting EL; 7m and 9m ignore LGD or use wrong differences.

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