State the simplified assumptions
The questions use a two-outcome model with zero loss in the non-default state. Loss given default and exposure are stated for the same horizon and valuation convention. More complex accounting or regulatory rules are outside these prompts.
Check what each number describes
Identify whether the prompt asks for a default-event loss, an expected loss or a probability. Multiplying by probability is appropriate for the expectation, not for the amount lost conditional on default.
Try the questions
PD is 2%, LGD is 45% and EAD is 100,000. What is expected loss in the simple one-horizon model?
- A.
45,000.
- B.
- C.
2,000.
Answer and explanation
Answer: B
0.02 × 0.45 × 100,000 = 900.
- A
That is the loss amount conditional on default, before applying its probability.
- B
Both percentage inputs are decimal fractions inside the multiplication.
- C
This applies probability to exposure but omits conditional loss severity.
Which statement describes an LGD of 45%?
- A.
If default occurs, the loss is 45% of the matching exposure under the stated model.
- B.
There is a 45% probability of default.
- C.
Expected loss across all outcomes is always 45% of exposure.
Answer and explanation
Answer: A
LGD describes the loss fraction conditional on default.
- A
This preserves the conditioning on default.
- B
That would describe a probability input, not conditional loss severity.
- C
Expected loss also depends on the probability of default and the other outcome losses.