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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

Which statement about expected loss and unexpected loss is most accurate for a bank's credit portfolio?

Unexpected loss measures how much actual losses may deviate from the expected average, and economic capital is held to absorb it. Expected loss is the average loss, which banks cover through loan pricing and provisions rather than capital.

  1. AExpected loss is the standard deviation of credit losses and is covered by economic capital
  2. BUnexpected loss is the average annual loss and is normally covered by pricing and provisions
  3. CUnexpected loss is the variability of losses around the expected level and is what economic capital is held to absorbCorrect
  4. DExpected loss is unpredictable and cannot be built into loan pricing

Explanation

Expected loss is the average anticipated loss, which is priced into loans and covered by provisions or reserves. Unexpected loss is the volatility of losses around that mean, and capital is held to absorb it. The options that swap these roles are wrong.

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