CFA Level I · CFA Level I Exam · Credit Risk
A bond has an exposure at default of $2,000,000, a probability of default of 3%, and a recovery rate of 40% of exposure. The expected loss is closest to:
Expected loss is about $36,000. Severity is 60% because recovery is 40%, so loss given default is $1,200,000. Multiplying by the 3% default probability gives $36,000. Using recovery as the loss gives $24,000, and ignoring recovery gives $60,000.
- A$24,000
- B$36,000Correct
- C$60,000
Explanation
Loss severity = 1 − 0.40 = 60%. Loss given default = 2,000,000 × 0.60 = 1,200,000. Expected loss = 0.03 × 1,200,000 = $36,000. Using the recovery rate instead of severity gives $24,000, while ignoring recovery gives $60,000.
Did you get it right without looking?
One question tells you little. A timed set on Credit Risk shows your real accuracy, how long you take and where you lose marks.
More Credit Risk questions
- Credit ratings issued by a major rating agency are most accurately described as:
- In a liquidation in which the absolute priority rule is followed, which of the following creditors is most likely to have the highest expect…
- Two senior unsecured bond issuers have identical cash flow coverage. Issuer X has substantial unencumbered assets, and Issuer Y has assets t…
- A corporate bond yields 5.40% and a government bond of the same maturity yields 3.90%. The yield spread of the corporate bond over the gover…
- Which factor is most likely to increase loss severity, rather than probability of default, for a given issuer?
- A 5-year corporate bond has a yield of 4.80%. The 5-year government par yield is 3.60% and the 5-year swap rate is 4.00%. The bond's I-sprea…