CFA Level I · CFA Level I Exam · Credit Risk
A bond is described as having a recovery rate of 40%. The loss given default (LGD) on a EUR 1,000,000 exposure at default is closest to:
The loss given default is about EUR 600,000. Loss given default equals the exposure multiplied by one minus the recovery rate, so 1,000,000 times 60% gives 600,000. The EUR 400,000 figure is the amount expected to be recovered, not the loss.
- AEUR 400,000
- BEUR 600,000Correct
- CEUR 960,000
Explanation
LGD = exposure × (1 − recovery rate) = 1,000,000 × (1 − 0.40) = EUR 600,000. EUR 400,000 is the amount recovered, which confuses recovery with loss. EUR 960,000 is wrongly computed as 1,000,000 × 0.96.
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