FRM Part I · FRM Exam Part I · Measuring Credit Risk
A loan of USD 10 million has a PD of 4% and a LGD of 50%, and the exposure is fixed with no uncertainty in LGD. Treating default as a Bernoulli event, what is the standard deviation of the credit loss (unexpected loss) on this loan?
With a fixed loss of USD 5 million if default occurs, the loss is a scaled Bernoulli variable. Its standard deviation is 5 million times the square root of 0.04 x 0.96, about USD 0.98 million.
- AUSD 0.98 million
- BUSD 1.96 millionCorrect
- CUSD 2.00 million
- DUSD 0.20 million
Explanation
Loss = EAD x LGD x default indicator. Exposure loss given default = 5 million. SD = 5 x sqrt(0.04 x 0.96) = 5 x 0.19596 = 0.9798 million... recheck: sqrt(0.0384)=0.19596, so 5 x 0.19596 = 0.98 million. Correct value is USD 0.98 million.
Did you get it right without looking?
One question tells you little. A timed set on Measuring Credit Risk shows your real accuracy, how long you take and where you lose marks.
More Measuring Credit Risk questions
- Which of the following best explains why a loan portfolio's unexpected loss is generally less than the sum of the stand-alone unexpected los…
- A firm has zero-coupon debt with face value 100 maturing in one year. The risk-free rate is 5% continuously compounded. In the Merton model …
- A bank lends USD 20 million to a firm and holds collateral currently worth USD 12 million after any haircut. Assume the exposure at default …
- In the Merton structural model of default, a firm is financed by equity and a single zero-coupon bond maturing at time T. Which description …
- A bank lends USD 50 million and receives collateral worth USD 40 million. The collateral is subject to a 10% haircut. Ignoring other adjustm…
- A bank has a single loan with exposure at default of 10,000,000. The one-year probability of default is 2% and the loss given default is 60%…