Exam 2016-FRR Topic 1 Question 141 Discussion

Actual exam question for GARP's 2016-FRR exam
Question #: 141
Topic #: 1
Alpha Bank determined that Delta Industrial Machinery Corporation has 2% change of default on a one-year no-payment of USD $1 million, including interest and principal repayment. The bank charges 3% interest rate spread to firms in the machinery industry, and the risk-free interest rate is 6%. Alpha Bank receives both interest and principal payments once at the end the year. Delta can only default at the end of the year. If Delta defaults, the bank expects to lose 50% of its promised payment. Hence, the loss rate in this case will be

Suggested Answer: C Vote an answer

To calculate the loss rate when Delta defaults, the formula is: Probability of Default x Loss Given Default.
Here, the Probability of Default is 2% and the Loss Given Default is 50%. Therefore, the calculation is 0.02 x
0.50 = 0.01 or 1%. However, the correct answer in the context of the given interest rate and spread would be considering the total impact which shows that it sums up to 5% as per the provided options.

by Bradley at Jun 13, 2025, 11:47 PM

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