aianjie

 

7、Smallville Savings Bank (SSB) has a loan portfolio totaling $20,000,000 in commitments. Currently 60% is outstanding. The bank has assessed an average internal credit rating equivalent to 2% default probability over the next year. Drawdown upon default is assumed to be 75%. The bank has additionally estimated a LGD of 60%. The standard deviation of EDF and LGD is 5% and 25%, respectively. The ratio of unexpected loss to expected loss is closest to:

A) 2.0.

B) 4.0.

C) 0.50.

D) 0.25.

aianjie

 

The correct answer is B

We can calculate the expected loss as follows:

EL = AE × EDF × LGD

Adjusted exposure = OS + (COM ? OS) × UGD = $20,000,000 × (0.6) + ($800,000) × (0.75) = $18,000,000.

EL = ($18,000,000) × (0.02) × (0.60) = $216,000.

Ratio = $834,626 / $216,000 = 3.86 (closest to 4.0).

aianjie

 

8、Smallville Savings Bank (SSB) has a loan portfolio totaling $20,000,000 in commitments. Currently 60% is outstanding. The bank has assessed an average internal credit rating equivalent to 2% default probability over the next year. Drawdown upon default is assumed to be 75%. The bank has additionally estimated a recovery rate of 60%. The standard deviation of EDF and LGD is 5% and 25%, respectively. The unexpected loss for SSB falls within which of the following ranges?

A) Greater than $750,000.

B) $250,001 to $500,000.

C) Less than $250,000.

D) $500,001 to $750,000.

aianjie

 

The correct answer is D

Note that a recovery rate of 60% implies a loss given default of 40%. We can calculate the expected loss as follows:

EL = AE × EDF × LGD

Adjusted exposure = OS + (COM ? OS) × UGD = $20,000,000 × (0.6) + ($8,000,000) × (0.75) = $18,000,000.

EL = ($18,000,000) × (0.02) × (0.40) = $144,000.

UL = 18,000,000×√(0.02 × 0.252 + 0.42×0.052) = $731,163

aianjie

 

9、Which of the following formulas for unexpected loss is CORRECT?

A)  [attach]13929[/attach] .

 

B)   [attach]13930[/attach].

 

C)  [attach]13931[/attach]
.

 

D) [attach]13932[/attach]
 .

aianjie

 

The correct answer is C

You can eliminate the two equations with LGD2 since LGD does not have square term. Then, you can eliminate the equation where the EDF term is multiplied by the VAR(LGD) term instead of VAR(EDF).

 

aianjie

 

AIM 3: Explain the relationship between economic capital and unexpected loss.

1、The type of capital used to buffer a bank from unexpected losses is known as:

A) regulatory capital.

B) unexpected capital.

C) risk-adjusted capital.

D) economical capital.

aianjie

 

The correct answer is D

It is imperative that a bank hold capital reserves (i.e., economic capital) to buffer itself from unexpected losses so that it can absorb large losses and continue to operate.

aianjie

 

2、Which of the following best describes the relationship between loan losses and economic capital?

A) Unexpected loss typically exceeds economic capital.

B) Economic capital typically exceeds unexpected loss.

C) Economic capital typically equals expected loss.

D) Expected loss typically exceeds economic capital.

aianjie

 

The correct answer is B

Economic capital represents the capital a bank sets aside to cover losses in atypical conditions. Thus, economic capital will reasonably be set above the unexpected loss level, e.g. two standard deviations.