# P1.T4.26. Unexpected loss (UL), Ong

Discussion in 'Today's Daily Questions' started by David Harper CFA FRM CIPM, Apr 10, 2012.

1. ### David Harper CFA FRM CIPMDavid Harper

AIMs: Explain the objective for quantifying both expected and unexpected loss. Describe factors contributing to expected and unexpected loss. Define, calculate and interpret the unexpected loss of an asset. Explain the relationship between economic capital, expected loss and unexpected loss.

Questions:

26.1. Of a total original commitment (COM) of $10.0 million, 20.0% is outstanding (OS) such that$8.0 million is unused. The usage given default (UGD) assumption is 50.0% and the loss given default (LGD) assumption is 40.0% where the standard deviation of the LGD is 30.0%. If the probability of default (EDF) is 2.0%, what is the unexpected loss (UL) on the adjusted exposure (AE)?

a. $48,000 b.$421,540
c. $573,495 d.$933,381

26.2. An exposure has a default probability (PD) of 4.0% and loss given default of 50.0%. The standard deviation of the LGD is 25.0%. What is the ratio of the unexpected loss to the expected loss, UL/EL?

a. 1.33
b. 3.72
c. 5.50
d. 9.64

26.3. In the assigned reading on unexpected loss (Ong Chapter 5), unexpected loss (UL) is given as: UL = AE * SQRT[EDF*variance(LGD) + LGD^2*variance(EDF)]. Each of the following is TRUE about this definition of unexpected loss (UL) EXCEPT:

a. It assumes independence (zero default correlation) between the default probability and loss given default (LGD)
b. Economic capital will necessarily equal this value of this unexpected loss, as defined; i.e., EC = UL
c. This unexpected loss (UL) is the standard deviation (volatility) of the unconditional value of the asset at the horizon
d. Whereas expected loss (EL) increases as a linear function of EDF and LGD, unexpected loss (UL) increases as a non-linear function of EDF and LGD

Answers: