FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management
Which statement best describes how a bank should treat expected loss and unexpected loss?
Expected loss is the average anticipated loss and is handled by loan pricing and provisions, whereas unexpected loss is the deviation from that average and is absorbed by capital. Capital is therefore held against unexpected loss, not expected loss.
- AExpected loss is covered through pricing and provisions, while capital is held against unexpected lossCorrect
- BExpected loss is covered by economic capital, while unexpected loss is covered by provisions
- CBoth are covered only by regulatory capital
- DUnexpected loss is the average loss and is charged to customers
Explanation
Expected loss is the predictable average loss and is a cost of doing business, priced into loans and provisioned. Unexpected loss is the variability around it, and capital acts as the buffer. The reverse assignment is wrong.
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