FRM Part II · FRM Exam Part II · Credit Risk
Under the Basel internal ratings-based (IRB) approach, the regulatory capital requirement for a corporate exposure is a function of which set of risk parameters supplied for the exposure?
IRB capital for a corporate exposure depends on probability of default, loss given default, exposure at default and effective maturity. These inputs feed the supervisory risk-weight formula, which also uses a prescribed asset correlation. PD alone is insufficient because loss severity, exposure size and tenor also change unexpected loss.
- AProbability of default, loss given default, exposure at default and effective maturityCorrect
- BProbability of default only, with all other inputs fixed by the supervisor in every case
- CCredit spread, recovery rate and the bank's equity price volatility
- DExpected shortfall, liquidity horizon and the bank's leverage ratio
Explanation
The IRB risk-weight function takes PD, LGD, EAD and maturity as inputs (with an asset correlation set by formula). Option B is wrong because LGD, EAD and maturity also drive the capital figure; PD is not the only input. Spreads, equity volatility, expected shortfall and leverage ratio are not the IRB inputs.
Did you get it right without looking?
One question tells you little. A timed set on Credit Risk shows your real accuracy, how long you take and where you lose marks.
More Credit Risk questions
- A bank holds a term loan with exposure at default of USD 20 million, a one-year probability of default of 2.5%, and a loss given default of …
- A bank's rating model is tested on 1,000 borrowers, of which 50 defaulted. Using the cumulative accuracy profile, the area under the model's…
- A bank uses the Basel III standardised approach for credit risk. It holds a USD 80 million unrated corporate exposure risk-weighted at 100%,…
- A risk analyst compares two portfolios with identical expected loss and identical individual obligor default probabilities. Portfolio X has …
- A CDS on a corporate bond has a notional of USD 20 million and a quoted spread of 250 basis points per year, paid annually for simplicity. T…
- A bank has a revolving credit line with a limit of USD 10 million, of which USD 4 million is drawn. The bank estimates that at default 50% o…