FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management
A bank's unsecured personal loan portfolio has 20,000 accounts with an average exposure at default of $5,000. The one-year probability of default is 3%, and the loss given default is 70%. What is the expected annual loss on the portfolio?
The expected loss is $2,100,000. Expected loss equals PD times LGD times EAD, so 3% times 70% times total exposure of $100 million gives $2.1 million. Ignoring loss given default would overstate the loss at $3 million.
- A$2,100,000Correct
- B$3,000,000
- C$4,200,000
- D$1,500,000
Explanation
Expected loss = PD x LGD x EAD. Total EAD = 20,000 x 5,000 = $100,000,000. EL = 0.03 x 0.70 x 100,000,000 = $2,100,000. The $3,000,000 option ignores LGD and treats the whole exposure as lost on default.
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