FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management
A portfolio has an expected annual credit loss of $12 million. The 99.9% worst-case annual credit loss is $95 million. Using the usual definition of economic capital as the buffer against unexpected loss at that confidence level, what economic capital is required?
Economic capital is $83 million. It equals the 99.9% worst-case loss of $95 million minus the expected loss of $12 million, since expected loss is covered by pricing and provisions and capital only needs to absorb the unexpected portion beyond that.
- A$12 million
- B$83 millionCorrect
- C$95 million
- D$107 million
Explanation
Economic capital = credit VaR at 99.9% minus expected loss = 95 - 12 = $83 million, because expected loss is already covered by provisions and pricing. $95 million ignores the expected loss deduction, and $107 million adds it with the wrong sign.
Did you get it right without looking?
One question tells you little. A timed set on The Building Blocks of Risk Management shows your real accuracy, how long you take and where you lose marks.
More The Building Blocks of Risk Management questions
- Two loans each have expected loss of $50,000 and unexpected loss (standard deviation of loss) of $300,000. Their losses have a correlation o…
- Two assets each have a standard deviation of 20%. A portfolio holds them 50/50. Which pair correlation gives a portfolio standard deviation …
- A bank estimates that the 99.9% worst-case annual credit loss on a portfolio is USD 95 million, while the expected loss is USD 30 million. U…
- A portfolio manager holds a diversified equity portfolio and is concerned only about one company's stock, which represents a small part of t…
- Which statement best explains why an insurance company can bear risks that individuals find difficult to bear?
- A company buys property insurance with a deductible. Which risk problem does the deductible primarily help to reduce?