Module: | MODULE B: RISK MANAGEMENT
Q377: Calculate the Expected Loss (EL) applicable for this transaction given the following raw data parameters:
* Outstanding Loan Exposure: ₹ 50,00,000
* Probability of Default (PD): 2.50%
* Recovery Rate: 40%
Calculate the Expected Loss (EL) applicable for this transaction.
* Probability of Default (PD): 2.50%
* Recovery Rate: 40%
Calculate the Expected Loss (EL) applicable for this transaction.
✅ Correct Answer: C
The correct answer is C. The core formula for calculating Expected Loss (EL) in credit risk management is: EL = PD × LGD × EAD.
Step 1: Determine the Loss Given Default (LGD). LGD is the fraction of the exposure lost in the event of default, calculated as (1 - Recovery Rate). Here, Recovery Rate is 40%, so LGD = 1 - 0.40 = 0.60 (or 60%).
Step 2: Identify Probability of Default (PD) and Exposure at Default (EAD). PD = 2.50% (or 0.025). EAD = ₹ 50,00,000.
Step 3: Calculate EL.
EL = 0.025 × 0.60 × 50,00,000.
0.60 × 50,00,000 = 30,00,000.
0.025 × 30,00,000 = 75,000.
Therefore, the Expected Loss is ₹ 75,000.
Expected loss is treated as a standard cost of doing business and is absorbed through loan pricing and standard provisioning.
Step 1: Determine the Loss Given Default (LGD). LGD is the fraction of the exposure lost in the event of default, calculated as (1 - Recovery Rate). Here, Recovery Rate is 40%, so LGD = 1 - 0.40 = 0.60 (or 60%).
Step 2: Identify Probability of Default (PD) and Exposure at Default (EAD). PD = 2.50% (or 0.025). EAD = ₹ 50,00,000.
Step 3: Calculate EL.
EL = 0.025 × 0.60 × 50,00,000.
0.60 × 50,00,000 = 30,00,000.
0.025 × 30,00,000 = 75,000.
Therefore, the Expected Loss is ₹ 75,000.
Expected loss is treated as a standard cost of doing business and is absorbed through loan pricing and standard provisioning.