Financial Risk Manager Part 2

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Explanation:

Expected credit loss (ECL) is additive across the portfolio and does not depend on default correlation. It is calculated as $\text{EAD} \times \text{PD} \times \text{LGD}$ , where $\text{LGD} = 1 - \text{Recovery Rate}$ .

For Bond A: $\text{ECL}_A = £1,000,000 \times 0.04 \times (1 - 0.70) = £12,000$ . For Bond B: $\text{ECL}_B = £800,000 \times 0.06 \times (1 - 0.60) = £19,200$ .

Total $\text{ECL} = £12,000 + £19,200 = £31,200$ .

Explanation:

For Bond A: $\text{ECL}_A = £1,000,000 \times 0.04 \times (1 - 0.70) = £12,000$ . For Bond B: $\text{ECL}_B = £800,000 \times 0.06 \times (1 - 0.60) = £19,200$ .

Total $\text{ECL} = £12,000 + £19,200 = £31,200$ .

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Q.17 A portfolio consists of two bonds – A and B. The credit VaR is defined as the maximum loss due to defaults at a confidence level of 99% over a one-year horizon. The probability of joint default of A and B is 1.45%, with 25% default correlation. Further details of the bonds are given in the table below:

Bond Value Default probability Recovery rate
A £1,000,000 4% 70%
B £800,000 6% 60%

Determine the expected credit loss for the portfolio.

Bond	Value	Default probability	Recovery rate
A	£1,000,000	4%	70%
B	£800,000	6%	60%

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Last updated: July 5, 2026 at 07:20

£12,000

£7,800

£31,200

£20,000