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

A risk analyst at a bank is calculating the expected loss on a corporate term loan. Which expression correctly gives the expected loss in terms of the standard credit risk parameters?

Expected loss is PD multiplied by LGD multiplied by EAD. It scales the chance of default by the fraction of exposure lost and by the amount exposed at default. Using one minus LGD would give recovery, not loss, and dividing by EAD is not valid.

  1. APD × LGD × EADCorrect
  2. BPD × (1 − LGD) × EAD
  3. C(1 − PD) × LGD × EAD
  4. DPD × LGD ÷ EAD

Explanation

Expected loss equals the probability of default multiplied by the loss given default (as a fraction of exposure) and the exposure at default. Using (1 − LGD) would instead measure the recovered amount, so option B is wrong. Using (1 − PD) weights by survival, not default.

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