Credit Risk Management Practice Exam

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In credit risk management, what does LGD refer to?

Loss Given Default
Liquidity Gain Data
Loan Generating Documents
Leverage Gain Decrease

The correct answer is: Loss Given Default

In credit risk management, LGD stands for Loss Given Default. This term is a critical metric used to assess the potential loss a lender may incur if a borrower defaults on a loan. It quantifies the percentage of an exposure that is expected to be lost in the event of default, after accounting for any recoveries through the liquidation of collateral or through other recovery means. Understanding LGD is essential for financial institutions as it helps in estimating capital requirements and in pricing loans properly. A higher LGD indicates a greater loss potential and suggests that the institution will face a more significant financial impact in case of borrower default. This metric is typically analyzed alongside other indicators, such as Probability of Default (PD) and Exposure at Default (EAD), to formulate a comprehensive view of credit risk. The other options do not relate to the established terminology within credit risk management, making them less applicable in this context.