In estimating credit exposure for a line of credit, it is usual to consider:

In estimating credit exposure for a line of credit, it is usual to consider:
A . a fixed fraction of the line of credit to be the exposure at default even though the currently drawn amount is quite different from such a fraction.
B . the full value of the credit line to be the exposure at default as the borrower has an informational advantage that will lead them to borrow fully against the credit line at the time of default.
C . only the value of credit exposure currently existing against the credit line as the exposure at default.
D . the present value of the line of credit at the agreed rate of lending.

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Answer: A

Explanation:

Choice’a’ is the correct answer. Exposures such as those to a line of credit of which only a part (or none) may be drawn at the time of assessment present a difficulty when attempting to quantify credit risk. It is not correct to take the entire amount of the line as the exposure at default, and likewise the current exposure is likely to be too aggressively low a number to consider.

While the borrower has an information advantage in that he would be aware of the deterioration in credit standing before the bank and would probably draw cash prior to default, it is unlikely that the entire amount of the line of credit would be drawn in all cases. In some cases, none may be drawn. In other cases, the bank would become aware of the situation and curtail or cancel access to the credit line in a timely fashion.

Therefore a fixed proportion of existing credit lines is considered a reasonable approximation of the exposure at default against credit lines.