Expected loss

The chance of default multiplied by the share not recovered. Both are averages, and they worsen together in a recession, so it understates the tail.

Where you will meet it

Expected loss appears in 6 learning outcomes on the CFA syllabus. A few of them:

• Set out the elements that make up credit risk
  CFA Level I · Fixed Income

  “Expected loss is the product of the probability of default and the loss given default, which is one minus the recovery rate, applied to the amount exposed.”

• Explain expected exposure, probability of default, loss given default and the adjustment to value for credit (CVA)
  CFA Level II · Fixed Income

  “Expected loss for a date is loss given default × probability of default.”

• Weigh risk and return across private credit strategies, and set them against other private market assets, in a strategic allocation
  CFA Level III · Private Markets Pathway

  “Deduct expected losses (probability of default × loss given default).”

• Work out expected loss using default probability and loss given default
  CFA Level I · Fixed Income

  “Expected loss is the probability of default multiplied by the loss given default, where loss given default is one minus the recovery rate applied to the exposure.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with E · Glossary