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Suppose that the assets of a bank consist of $500 million of loans to A-rated corporations. The PD for the corporations is estimated as 0.3%.
Suppose that the assets of a bank consist of $500 million of loans to A-rated corporations. The PD for the corporations is estimated as 0.3%. The average maturity is three years and the LGD is 60%.
- What are the expected losses and unexpected losses for the loans under foundation IRB approach? A rating corresponds to 0.01% of default rate.
- How much capital is needed for the loans under the foundation IRB approach?
- How does the capital required in foundation IRB compare with the capital required under the Basel II standardized approach? Calculate both and illustrate why one is higher than the other.
- If analysts of the bank forecast an increase of risk in corporate debt market, which leads to a higher PD and LGD, what should the bank do to manage the credit risk?
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