A portfolio consists of two (long) assets £100 million each. The probability of default over the next year is 10% for the first asset, 20% for the second asset, and the joint probability of default is 3%.
Estimate the expected loss on this portfolio due to credit defaults over the next year assuming 40% recovery rate for both assets.
1)£19 million
2)£22 million
3)£30 million
4)None of the above
Which is correct answer?
My attempted answer:
Computation of weighted average default probability = £100,000,000 × 0.1 × 0.6 + £100,000,000 × 0.2 × 0.6 + £200,000,000 × 0.03 × 0.6 = £21,600,000
So my answer is £22,000,000 approx.
Answer provided is given below:
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