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Answer: Exposure amount (EA) is the standard deviation of credit losses estimated at the end of the horizon excluding outstanding interest payments.
## Explanation **Option A is incorrect** because: - Exposure amount (EA) is NOT the standard deviation of credit losses - EA represents the total amount at risk when default occurs, typically including both principal and outstanding interest payments - Standard deviation relates to the volatility of losses, not the exposure amount itself **Option B is correct** because: - Probability of default (PD) is indeed defined as the likelihood that a borrower will default within a specified time period - This is a standard definition in credit risk management In expected loss calculations: - **EL = PD × EA × LR** - **EA (Exposure Amount)**: The total outstanding balance at the time of default, including principal and interest - **PD (Probability of Default)**: The likelihood of default occurring within a given time horizon - **LR (Loss Rate)**: The percentage of exposure that will not be recovered in the event of default Option A misrepresents the definition of exposure amount by incorrectly describing it as a standard deviation measure and excluding interest payments, which are typically included in exposure calculations.
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Expected loss (EL) has three components: probability of default (PD), exposure amount (EA), and loss rate (LR). With respect to these components of EL, each of the following is true EXCEPT which is not accurate?
A
Exposure amount (EA) is the standard deviation of credit losses estimated at the end of the horizon excluding outstanding interest payments.
B
Probability of default (PD) is the probability that a borrower will default before the end of the relevant period.
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