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    Question

    Expected Loss (EL) in credit risk refers to the

    anticipated financial loss from a borrower's default . Which of the following is NOT one of the components required for credit risk quantification under the EL model ?
    A Probability of Default (PD) Correct Answer Incorrect Answer
    B Loss Given Default (LGD) Correct Answer Incorrect Answer
    C Exposure at Default (EAD) Correct Answer Incorrect Answer
    D Credit Score before Default (CSD) Correct Answer Incorrect Answer
    E All are part of the EL model Correct Answer Incorrect Answer

    Solution

    Expected Loss (EL) in credit risk refers to the anticipated financial loss from a borrower's default, encompassing the probability of default (PD), the potential loss given default (LGD), and the exposure at default (EAD). It is a key metric for assessing , quantifying and managing credit risk, helping financial institutions estimate potential losses and make informed decisions about lending, pricing, and risk management.    Components of EL:  

    • Probability of Default (PD):  The likelihood that a borrower will not repay a loan or meet other financial obligations.   
    • Loss Given Default (LGD):  The percentage of the outstanding loan balance that a lender is expected to lose if a borrower defaults, accounting for collateral recovery.   
    • Exposure at Default (EAD):  The total amount of credit exposure a lender has at the time of default, including outstanding loan balances.   
    Calculation:   EL = PD * LGD * EAD   

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