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FRM Part II · FRM Exam Part II · Credit Value at Risk

A loan portfolio has exposure of USD 500 million, LGD of 40% and a one-year PD of 2% per loan. A Vasicek model gives a 99.9% worst-case default rate of 8%. The risk manager wants the unexpected loss, that is, the credit VaR in excess of expected loss, as the economic capital figure. What is it?

The unexpected loss is USD 12 million. The 99.9% credit VaR is 500m × 40% × 8% = 16m, and expected loss is 500m × 40% × 2% = 4m. Capital for unexpected loss is the difference, 12m, not the full 16m VaR.

  1. AUSD 16 million
  2. BUSD 12 millionCorrect
  3. CUSD 4 million
  4. DUSD 20 million

Explanation

Credit VaR at 99.9% = 500 × 0.40 × 8% = USD 16m. Expected loss = 500 × 0.40 × 2% = USD 4m. Unexpected loss = 16 - 4 = USD 12m. USD 16m ignores the subtraction of expected loss, and USD 4m is only the expected loss.

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