Credit Risk Management Practice Exam

In credit risk analysis, what does EAD stand for?

1. Exposure at Default

2. Expected Asset Devaluation

3. Equity at Default

4. Excessive Accounts Debt

The correct answer is: Exposure at Default

EAD stands for Exposure at Default, which is a crucial concept in credit risk analysis. It represents the total value that a lender is exposed to at the time of a borrower's default. Essentially, EAD quantifies the potential loss that a financial institution would incur if a loan were to default. This metric is vital for calculating various risk parameters, including the required capital reserves to cover expected losses and the overall risk management strategies of financial institutions. Understanding EAD is especially important in regulatory contexts, as it influences how institutions determine their capital needs under frameworks like the Basel Accords. By accurately assessing EAD, lenders can better manage their risk exposures and implement measures to mitigate potential losses. This concept is foundational in credit risk modeling and is used alongside other parameters such as Probability of Default (PD) and Loss Given Default (LGD) in the context of assessing credit risk.