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FRM Part II · FRM Exam Part II · Introduction to Operational Risk and Resilience

A bank's scenario analysis for a severe payment-system outage estimates a frequency of one event every 20 years. Experts estimate the loss if it occurs at USD 60 million with a probability of 0.5, and USD 20 million otherwise. The bank also faces a separate fraud scenario with expected annual loss of USD 0.5 million. What is the combined expected annual loss from these two scenarios?

The combined expected annual loss is USD 2.5 million. Expected outage severity is 40 million (average of 60 and 20), multiplied by frequency of 0.05 per year gives 2.0 million, and adding the fraud scenario's 0.5 million yields 2.5 million.

  1. AUSD 2.5 millionCorrect
  2. BUSD 2.0 million
  3. CUSD 3.0 million
  4. DUSD 40.5 million

Explanation

Expected severity = 0.5×60 + 0.5×20 = 40 million. Frequency is 1/20 = 0.05 per year, so expected annual outage loss = 2.0 million. Adding fraud 0.5 million gives 2.5 million. Omitting the fraud scenario gives 2.0; 3.0 comes from mistaking frequency; 40.5 ignores frequency.

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