Skip to content

FRM Part I · FRM Exam Part I · Measuring Credit Risk

Which statement about expected and unexpected credit losses is most accurate?

Expected loss is the anticipated average loss, which banks cover through pricing and provisions. Unexpected loss is the volatility of losses around that average, and capital is held against it. Expected loss is additive and unaffected by correlation, and portfolio unexpected loss is less than the sum unless correlation is perfect.

  1. AExpected loss is normally covered through loan pricing and provisions, while unexpected loss is covered by capital.Correct
  2. BUnexpected loss is the average loss and is covered by loan loss provisions.
  3. CExpected loss falls as default correlation within the portfolio rises, holding PD, LGD and EAD fixed.
  4. DUnexpected loss on a portfolio is always the sum of the unexpected losses on its individual loans.

Explanation

Expected loss is a predictable cost of lending, so it is priced and provisioned, while capital buffers the volatility of losses. Expected loss does not depend on correlation (it is additive). Portfolio unexpected loss equals the simple sum only under perfect correlation; otherwise diversification reduces it.

Did you get it right without looking?

One question tells you little. A timed set on Measuring Credit Risk shows your real accuracy, how long you take and where you lose marks.

Practise Measuring Credit RiskFree diagnostic mock

More Measuring Credit Risk questions