2010 Practice Level II_1-20_v3_0824 GARP Prac Exam Q 19

[Jhamby]

David, in the answer given in Q19.2 of the GARP Practice Exam Questions, it makes reference to the Variance of EDF being the square root of p*(1-p) and provides a link to Wikipedia: http://en.wikipedia.org/wiki/Bernoulli_distribution.

19.2 Assume both credits (credit A & credit B) have the same parameters: Commitment = $4 million; Outstanding (OS) = $2 million; usage given default (UGD) = 50%; probability of default (PD or EDF) = 2%; loss given default (LGD) = 60%; and standard deviation of LGD = 25%. What is the expected loss (EL) and unexpected loss (UL) of each credit? Adjusted exposure (AE) = $2 MM OS + $2 MM unused * 50% UGD = $3 MM
Variance of EDF = SQRT(98%*2%). Did you remember that the variance of a Bernoulli is p*q or p*(1-p)?

However, the Wiki article that makes no mention of the variance of a Bernoulli being the square root. I'm confused. Is that a typo?

Thanks.

 

[David Harper CFA FRM]

Hi @Jhamby Yes, that's a typo (sorry). It should be, true is: Variance of EDF = 98%*2%; instead, it is the standard deviation of EDF that is given by sqrt[p*(1-p)] = sqrt[98%*2%]. Sorry for the confusion!