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FRM Part II · FRM Exam Part II · Credit Scoring and Retail Credit Risk Management

A mortgage lender has a loan with a current balance of $400,000 secured by a property now valued at $500,000. Upon default, the property is sold for 80% of current value, and foreclosure and selling costs total $20,000. Ignoring accrued interest and discounting, what is the loss given default as a percentage of exposure?

LGD is 5%. The property sells for $400,000 (80% of $500,000), costs of $20,000 reduce net recovery to $380,000, leaving a $20,000 loss on a $400,000 exposure. Ignoring foreclosure costs would wrongly suggest no loss.

  1. A0%
  2. B5%Correct
  3. C10%
  4. D20%

Explanation

Sale proceeds = 0.80 x 500,000 = $400,000. Net recovery = 400,000 - 20,000 = $380,000. Loss = 400,000 - 380,000 = $20,000, so LGD = 20,000/400,000 = 5%. Choosing 0% ignores the costs of foreclosure.

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