Explanation:
The correct answer is D.
The expected loss for a credit portfolio can be calculated by multiplying the default probability of each bond by its notional value and the difference between 1 and the recovery rate. The expected loss is then the sum of these individual expected losses for each bond.
For Bond A, the expected loss is 1% * $10 million * (1 - 40%) = $60,000
For Bond B, the expected loss is 2% * $10 million * (1 - 60%) = $80,000
The expected loss for the credit portfolio after one year is $60,000 + $80,000 = $140,000
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Q.5540 You are analyzing a credit portfolio consisting of several bonds. Each bond has a default probability and a recovery rate associated with it. Each bond in the portfolio has a notional value of $10 million. Consider two correlated bonds, Bond A and Bond B. The default probability for Bond A is 1%, with a recovery rate of 40%. The default probability for Bond B is 2%, with a recovery rate of 60%. The default probabilities for the other bonds in the portfolio are negligible. Calculate the expected loss for the credit portfolio after one year.
A
$240,000
B
$80,000
C
$60,000
D
$140,000
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