Dear David,
I’ve have struggling with the following question from FRM practice and past exams. Appreciate your kind help on this!
11) On Portfolio VAR (FRM exam 2000 question 36)
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 zero recovery rate.
Answer provided: The probability of only one default is equal to .10 + .20 - 2 x .03 = .24, the cost of this is £100. The probability of both defaulting is .03, the cost is £200. The total risk is 100 × .24 + 200 × .03 = £30 million.
My question: Can I use a different approach to calculate the expected loss, which is also simpler?
Expected portfolio loss = ∑▒ELi where EL1 = 0.1 x 100 = 10 and EL2 = 0.2 x 100 = 20
So irregardless of the correlation, the portofilo expected loss is 10+20 = 30 million.
Thank you for your enlightenment and correction!
Cheers
Liming
10/11/09
I’ve have struggling with the following question from FRM practice and past exams. Appreciate your kind help on this!
11) On Portfolio VAR (FRM exam 2000 question 36)
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 zero recovery rate.
Answer provided: The probability of only one default is equal to .10 + .20 - 2 x .03 = .24, the cost of this is £100. The probability of both defaulting is .03, the cost is £200. The total risk is 100 × .24 + 200 × .03 = £30 million.
My question: Can I use a different approach to calculate the expected loss, which is also simpler?
Expected portfolio loss = ∑▒ELi where EL1 = 0.1 x 100 = 10 and EL2 = 0.2 x 100 = 20
So irregardless of the correlation, the portofilo expected loss is 10+20 = 30 million.
Thank you for your enlightenment and correction!
Cheers
Liming
10/11/09
