2016-FRR Exam Dumps | ThetaBank has extended substantial financing to two mortgage companies, which these mortgage lenders

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Financial Risk and Regulation (FRR) Series
GARP.2016-FRR.v2024-09-09.q145
Question 121

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Question 121/145

ThetaBank has extended substantial financing to two mortgage companies, which these mortgage lenders use to finance their own lending. Individually, each of the mortgage companies has an exposure at default (EAD) of $20 million, with a loss given default (LGD) of 100%, and a probability of default of 10%. ThetaBank's risk department predicts the joint probability of default at 5%. If the default risk of these mortgage companies were modeled as independent risks, what would be the probability of a cumulative $40 million loss from these two mortgage borrowers?

A. 0.01%

B. 0.1%

C. 1%

D. 10%

Correct Answer: C

* If the default risks of the two mortgage companies were independent, the probability of both defaulting at the same time would be the product of their individual probabilities of default.
* Probability of a single default is 10%, so for both to default: 0.1 * 0.1 = 0.01 or 1%.
References:
* How Finance Works: "The probability of independent default events occurring simultaneously is the product of their individual probabilities."

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