FRM Part II · FRM Exam Part II · Credit Risk
Under the Vasicek single-factor model underlying IRB, a portfolio has PD of 2%, LGD of 50% and the worst-case default rate at 99.9% is 20%. Ignoring maturity adjustment and scaling factors, what is the capital requirement K per unit of exposure?
Capital is 9.0% of exposure. K equals LGD times the difference between the worst-case default rate and PD: 50% times (20% minus 2%) equals 9%. Subtracting PD removes expected loss, leaving only unexpected loss to be covered by capital.
- A9.0%Correct
- B10.0%
- C11.0%
- D20.0%
Explanation
K = LGD x (WCDR - PD) = 0.5 x (0.20 - 0.02) = 0.09. The 11% option uses WCDR x LGD, which is 10%, minus nothing wrongly then plus... it adds PD x LGD instead of subtracting; 10% ignores the expected loss deduction; 20% is the raw WCDR.
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