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FRM Part II · FRM Exam Part II · Portfolio Credit Risk

A credit portfolio manager compares two portfolios with the same total exposure and the same expected loss. Portfolio A has 50 equal exposures. Portfolio B has 5 equal exposures. All obligors have the same PD and the same pairwise default correlation. Which conclusion is most appropriate?

Portfolio A has lower unexpected loss. With the same expected loss and the same pairwise default correlation, spreading exposure across 50 names rather than 5 reduces single-name concentration and idiosyncratic risk, although the systematic component remains in both.

  1. APortfolio B has lower unexpected loss because larger exposures are easier to monitor
  2. BBoth portfolios have identical unexpected loss because expected loss is the same
  3. CPortfolio B has lower unexpected loss because its default correlation per exposure is lower
  4. DPortfolio A has lower unexpected loss because greater granularity reduces idiosyncratic concentrationCorrect

Explanation

With equal expected loss and identical correlation, more names mean less single-name concentration, so unexpected loss is lower for A. Identical expected loss does not imply identical unexpected loss, and correlation is the same by assumption.

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