IMDP Risk Management Practice Test

When estimating expected credit losses, you combine three quantities: the probability that the borrower will default (PD), the amount exposed at the time of default (EAD), and the portion of that exposure that would be lost if default occurs (LGD). The expected loss is roughly PD × EAD × LGD, capturing how likely the default is, how much credit is at risk when default happens, and how severe the loss would be. For example, with a 5% PD, an exposure at default of 100,000, and an LGD of 60%, the estimated loss is 0.05 × 100,000 × 0.60 = 3,000. These three components specifically represent default likelihood, exposure level at default, and loss severity, which is why they are used together to estimate expected credit losses. Other options refer to pricing factors, liquidity metrics, or operational risk and do not form the ECL calculation.