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CA Final · Advanced Financial Management · Risk Management

Sundaram Textiles Ltd has a bond exposure of ₹50 crore to a counterparty. The probability of default (PD) over the year is 2%, the loss given default (LGD) is 60%, and exposure at default (EAD) is ₹50 crore. What is the expected loss for the year?

Expected loss is the product of probability of default, loss given default and exposure at default. Here 2% × 60% × ₹50 crore equals ₹0.60 crore. Ignoring LGD gives ₹1 crore, which overstates the loss because part of the exposure is recovered after default.

  1. A₹0.60 croreCorrect
  2. B₹1.00 crore
  3. C₹0.40 crore
  4. D₹30.00 crore

Explanation

Expected loss = PD × LGD × EAD = 0.02 × 0.60 × 50 = ₹0.60 crore. Option ₹1.00 crore ignores LGD (0.02 × 50). Option ₹0.40 crore uses recovery rate (40%) instead of LGD. ₹30 crore is the loss given default itself, ignoring PD.

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