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Answer: The expected loss is $350,000, while the unexpected loss is $1,650,000.
## Explanation ### Step 1: Calculate Expected Loss (EL) Expected Loss is calculated as: \[ EL = PD \times LGD \] Where: - PD = Probability of Default = 5% = 0.05 - LGD = Loss Given Default = $7,000,000 \[ EL = 0.05 \times 7,000,000 = 350,000 \] ### Step 2: Calculate Unexpected Loss (UL) Unexpected Loss is calculated as: \[ UL = VaR - EL \] Where: - VaR = Value at Risk = $2,000,000 - EL = Expected Loss = $350,000 \[ UL = 2,000,000 - 350,000 = 1,650,000 \] ### Step 3: Verify the Answer - Expected Loss = $350,000 - Unexpected Loss = $1,650,000 This matches **Option B**. ### Key Concepts - **Expected Loss (EL)**: The average loss expected over a given time period, calculated as PD × LGD - **Unexpected Loss (UL)**: The potential loss beyond the expected level, often measured as VaR minus EL - **Value at Risk (VaR)**: The maximum potential loss at a given confidence level over a specified time period
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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.
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