Question 15.13: Equation (15.9) gives the formula for the capital required u...
Equation (15.9) gives the formula for the capital required under Basel II. It involves four terms being multiplied together. Explain each of these terms.
EAD × LGD × (WCDR − PD) × MA (15.9)
EAD is the estimated exposure at default. LGD is the loss given default, which is the proportion of the exposure that will be lost if a default occurs. WCDR is the one-year probability of default in a bad year that occurs only one time in 1,000. PD is the probability of default in an average year. MA is the maturity adjustment, which allows for the fact that, in the case of instruments lasting longer than a year, there may be losses arising from a decline in the creditworthiness of the counterparty during the year as well as from a default during the year.