Credit Risk Management Practice Exam

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What does stressed expected loss (ELS) measure?

The fixed loss in a normal environment
The difference between stressed EL and expected EL
The average historical loss over a financial instrument
The probability of default in a static model

The correct answer is: The difference between stressed EL and expected EL

Stressed expected loss (ELS) is a measure that quantifies potential losses under adverse conditions, taking into account scenarios that are worse than typically expected. It is defined as the difference between stressed expected loss and the regular expected loss. This measure helps financial institutions understand how their portfolios may perform during economic downturns or periods of distress, thus allowing them to assess their credit risk in more challenging environments. By analyzing the difference, stakeholders can identify how much additional risk is introduced under stressed conditions compared to normal market situations, which is crucial for effective risk management and capital allocation strategies.