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Answer: The expected loss is $350,000, while the unexpected loss is $1,650,000.
## Explanation ### Expected Loss Calculation Expected Loss (EL) = Probability of Default (PD) × Loss Given Default (LGD) Given: - Probability of Default (PD) = 5% = 0.05 - Loss Given Default (LGD) = $7,000,000 EL = 0.05 × $7,000,000 = $350,000 ### Unexpected Loss Calculation Unexpected Loss (UL) = Value-at-Risk (VaR) - Expected Loss (EL) Given: - VaR = $2,000,000 - EL = $350,000 UL = $2,000,000 - $350,000 = $1,650,000 ### Key Points: - **Expected Loss** represents the average loss that is expected to occur over time - **Unexpected Loss** represents the potential loss beyond the expected level, measured by VaR minus expected loss - The exposure amount ($10 million) is not directly used in these calculations since we already have the LGD ($7 million) Therefore, the correct answer is: - Expected Loss = $350,000 - Unexpected Loss = $1,650,000
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A credit risk analyst is analyzing an individual loan. The exposure amount at default of this loan is assumed to be $10 million. Based on the historical data, the analyst has estimated the following:
$7 million.Further, the analyst has computed the Value-at-Risk (VaR) for this loan, which equals $2 million. What is the expected loss and unexpected loss of this loan?
A
The expected loss is $350,000, while the unexpected loss is $2,000,000.
B
The expected loss is $350,000, while the unexpected loss is $1,650,000.
C
The expected loss is $700,000, while the unexpected loss is $2,000,000.
D
The expected loss is $700,000, while the unexpected loss is $1,650,000.