Statement 1:The expected loss metric and present value of expected loss metric differ only in terms of time value of money and discounting of expected future losses.
statement 1 is most likely:
- correct.
- incorrect, because the expected loss computation uses risk-neutral probabilities.
- incorrect, because the present value of expected loss also adjusts default probabilities to capture the riskiness of the cash flows (i.e., the risk premium).
Can someone help me with this question? I know that for the Structural model, the expected loss metric uses a growth rate, while the PV of expected loss uses a risk free. But what about the reduce form? How does the reduce form expected loss and PV of expected loss capture riskiness of the cash flow? Many thanks.