Explanation:
Expected loss (EL) is anticipated and viewed as a normal cost of doing business, not a risk. Therefore, it does not require economic capital (which is held to cover unexpected losses). Instead, EL is calculated on a transaction-by-transaction basis (bottom-up using PD × LGD × EAD) and is provisioned for and reimbursed through the loan's pricing (the interest rate spread charged to the borrower). Options A and D incorrectly conflate expected loss with unexpected loss/risk. Option B is false because while expected loss is an average, actual credit losses do fluctuate year to year.
505.2. Which of the following is TRUE about expected credit loss?
A
Expected loss itself constitutes risk
B
Expected loss represents credit loss levels that do NOT fluctuate year to year
C
Expected loss is calculated from the bottom up (transaction by transaction) and reimbursed through adequate loan pricing
D
Expected loss is the risk that arises due to the variation in loss levels and therefore justifies the rationale for economic capital
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