Financial Risk Manager Part 1
Get started today
Ultimate access to all questions.
In financial risk management, particularly in relation to credit risk, two key concepts are 'expected loss' and 'unexpected loss'. These terms are used to estimate potential credit losses and are integral to the risk management strategies of financial institutions. Which of the following accurately differentiates between expected loss and unexpected loss?
Other
Community
TTanishq
A
Expected loss is the average credit loss we expect from an exposure while unexpected loss is the loss that occurs over and above the expected loss.
B
Unexpected loss is the average credit loss we expect from an exposure while expected loss is the loss that occurs over and above the unexpected loss.
C
Expected loss is the average credit loss that we would expect from an exposure while unexpected loss is the loss that would occur without a quantitative expression.
D
Expected loss is the average credit loss that we would expect from an exposure while unexpected loss is the sum of expected losses from several time periods.
Explanation:
Explanation
Expected loss is the average credit loss that we would expect from an exposure over a given period of time. It is calculated as the product of the probability of default (PD), the loss given default (LGD), and the exposure at default (EAD). Expected loss is a key component of credit risk management and is used to estimate the amount of capital that a bank needs to hold to cover potential credit losses.
Unexpected loss is the amount of loss that actually exceeds the expected amount. It is the difference between the expected loss and the actual loss incurred. Unexpected loss is also known as the tail risk or the potential loss in extreme scenarios. It represents the risk that the actual losses may be much higher than the expected losses, which can have a significant impact on a bank's capital and profitability.
Why other options are incorrect:
- Choice B reverses the definitions of expected loss and unexpected loss.
- Choice C is incorrect because unexpected loss is quantitatively expressed as the difference between the expected loss and the actual loss incurred. It is not a nebulous or unquantifiable concept, but a specific measure used in financial risk management.
- Choice D is incorrect because unexpected loss is not a cumulative measure of expected losses over time. Instead, it is the difference between the expected loss and the actual loss incurred in a given period.
Comments
Loading comments...