Skip to content

FRM Part II · FRM Exam Part II · Capital Regulation Before the Global Financial Crisis

Which statement best describes a key feature of the Basel II IRB risk-weight formula for corporate exposures, as it relates to capital for unexpected loss?

The IRB formula is a single-factor model that sets capital for unexpected loss only, at 99.9% confidence over one year. Asset correlation falls as PD rises, and expected loss is covered by provisions rather than capital. It is not a fixed percentage or a multi-factor 95% measure.

  1. ACapital covers expected and unexpected losses at the 99.9% confidence level, with expected loss deducted via provisions
  2. BCapital covers only unexpected loss at 99.9% confidence, based on a single-factor model with asset correlation depending on PDCorrect
  3. CCapital is a fixed percentage of exposure, independent of PD and maturity
  4. DCapital covers unexpected loss at 95% confidence using a multi-factor model with constant correlation

Explanation

The IRB formula derives from the asymptotic single risk factor model (Vasicek), setting capital for unexpected loss at 99.9% over one year. Expected loss is handled separately through provisions, and asset correlation declines as PD rises. The first option is wrong because capital is for unexpected loss only, not expected loss plus unexpected loss, even though EL is compared with provisions.

Did you get it right without looking?

One question tells you little. A timed set on Capital Regulation Before the Global Financial Crisis shows your real accuracy, how long you take and where you lose marks.

Practise Capital Regulation Before the Global Financial CrisisFree diagnostic mock

More Capital Regulation Before the Global Financial Crisis questions