A portfolio consists of one (long) $100M asset and a default protection contract on this asset. The probability of default over the next year is 10% for the asset, 20% for the counterparty that wrote the default protection. The joint probability of default is 3%. Estimate the expected loss on this portfolio due to credit defaults over the next year assuming 40% recovery rate on the asset and 0% recovery rate for the counterparty.

Answer rating: 100% (QA)

There are two possible cases where there can be a loss Case 1 If the asset defaults but the counter ... View the full answer