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

A risk manager describes a bank's credit loss distribution for a loan portfolio over one year. Which statement best characterizes the shape of this distribution and its implication for risk measurement?

Credit loss distributions are right-skewed with a fat tail because most years produce small losses while rare clustered defaults produce very large ones. Standard deviation alone understates this tail risk, so percentile-based measures like credit VaR are more informative for capital.

  1. AIt is roughly symmetric, so standard deviation fully captures tail risk
  2. BIt is right-skewed with a fat tail, so tail measures such as credit VaR matter more than standard deviation aloneCorrect
  3. CIt is left-skewed, so the largest losses occur frequently
  4. DIt is uniform, so all loss levels are equally likely

Explanation

Credit losses are bounded below by zero and have a small probability of very large losses from clustered defaults, giving a right-skewed, fat-tailed distribution. Standard deviation understates this tail, so percentile-based measures are needed. A symmetric assumption would misstate capital.

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