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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:

Credit risk management

Additional helpful information:

CRM1

CRM2 CRM3

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  • 1
    Please show some effort on what exactly you tried.
    – base64
    Feb 12 at 6:36
  • Did your text book discuss credit defaults and recovery rates? Feb 12 at 12:23
  • This is not a -personal finance question.
    – JohnFx
    Feb 12 at 18:20

1 Answer 1

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Computation of expected loss on this portfolio due to credit defaults over the next year assuming 40% recovery rate for both assets:

£100 million × 0.6 × 0.07 + £100 million × 0.6 × 0.17 + £200 million × 0.6 × 0.03 = £18 million which is very close to £19 million, hence the answer to this question is £19 million

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