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IBBC CAPITAL ACADEMY / 2027

Default losses and changing credit spreads

Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.

Learning goals

  • Explain loss components using mechanisms and limitations.
  • Explain ratings and information using mechanisms and limitations.
  • Explain spread drivers using mechanisms and limitations.

Draft · approximately 25 minutes, excluding further revision.

Loss components

Expected credit loss combines probability of default, loss given default and exposure under a specified horizon; it is an average, not a maximum possible loss.

Recovery and loss given default are complements when measured on the same exposure basis; collateral, priority and restructuring costs affect actual recovery.

Ratings and information

Credit ratings summarize an agency opinion and can lag new information; they are neither a recommendation nor a guarantee against migration or default.

A credit spread compensates for several risks including expected losses, uncertainty and liquidity; spread is not a direct probability of default without a model.

Spread drivers

Economic slowdown, funding stress and risk aversion can widen many spreads together, while issuer leverage or business shocks create security-specific moves.

Credit deterioration can create mark-to-market losses before any missed payment; distinguish spread risk from realized default loss.

Formula and assumptions

EL=PD×LGD×EAD; LGD=1−recovery rate

Original applied case: Default losses and changing credit spreads

  1. Exposure 1,000,000, one-year default probability 2%, expected recovery 40%; ignore discounting.
  2. LGD=60%; expected loss=1,000,000×0.02×0.60=12,000.
  3. Actual outcomes can be zero loss or far more; this is not a guaranteed annual charge.

Errors to catch

  • Do not assume: Expected loss is the maximum possible loss.
  • Do not assume: Recovery and LGD sum to 200% on the same basis.
  • Do not assume: A rating guarantees repayment.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.