Discuss PRMIA 8010 Exam Topic 1 Question 90

If E denotes the expected value of a loan portfolio at the end on one year and U the value of the portfolio in the worst case scenario at the 99% confidence level, which of the following expressions correctly describes economic capital required in respect of credit risk?

AE - U

BU/E

Suggested Answer: A

Economic capital in respect of credit risk is intended to absorb unexpected losses. Unexpected losses are the losses above and beyond expected losses and up to the level of confidence that economic capital is being calculated for. The capital required to cover unexpected losses in this case is E - U, and therefore Choice 'a' is the correct answer.

This question does raise an important point - are expected losses a part of economic capital, or are they not? Different text books say different things, and sometimes they say both the things. I have tried to take an approach that uses what I read in the PRMIA handbook.

This writeup - http://www.riskprep.com/all-tutorials/37-exam-3/111-credit-var-an-intuitive-understanding - may help clarify things further.

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12 comments · newest first

Brett 1 month ago

I feel like C) U could be right too. It’s the worst case value, but not sure if it captures the risk fully.

Craig 1 month ago

I’m leaning towards B) U/E. It shows the ratio of worst case to expected.

Josephine 1 month ago

This question is tricky! I think it's A) E - U. It makes sense to measure the gap.

Freeman 2 months ago

U/E doesn't really fit the context here.

Bernadine 2 months ago

Wait, are we sure about this? Seems off to me.

Fatima 2 months ago

Totally agree with France, E - U makes sense.

Tomoko 2 months ago

I think it's just U, right?

France 2 months ago

It's definitely U - E that shows the risk!

Tambra 2 months ago

I thought economic capital was about how much you need to cover unexpected losses, so I lean towards A) E - U, but I'm not 100% confident.

Deeanna 3 months ago

I'm not entirely sure, but I feel like U represents the worst-case loss, so maybe it stands alone as the capital needed? That would make C) U a possibility.

Roy 3 months ago

I remember practicing a question where we had to find the difference between expected value and worst-case scenarios. Could it be A) E - U?

Gabriele 3 months ago

I think the economic capital is related to the potential loss, so maybe it's something like U - E? But none of the options seem to match that.

PRMIA 8010 Exam - Topic 1 Question 90 Discussion