Explanation:
Concentration risk is the risk of financial loss due to a concentrated exposure to a particular group of counterparties.
With a single borrower, concentration = 1. With three, the concentration ratio would be reduced to 1/3
Note: Similarly, the concentration ratio for a creditor with 100 loans of equal size to different entities is 0.01 (= 1/100).
Things to Remember
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Q.1558 Suppose that MLA Commercial Bank has lent Rs.10,000 to a single company, named X. Therefore, MLA Commercial Bank’s concentration ratio is 1. In addition, suppose company X has a default probability P(x) of 10%. The expected loss from company X is Rs.10,000 x 0.1 = Rs.1,000. Now, if MLA Commercial Bank lent the same amount of Rs.10,000 among three different companies, assuming a default risk of 10% each, what will be the concentration ratio for the bank?
A
0.5
B
1
C
0.3
D
0.333
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