Hi,I am trying to evaluate credit risk of a bond portfolio and the first step is to calculate expected loss:EL = Exposure * PD * LGDI have a few questions:A bank purchases a bond at a discount. What is the exposure: is it the face value or the paid price?Is it different for bonds purchased at the issue or purchased on the secondary market?and more general question:In terms of common practice, does the exposure include the future interest on a loan or it is just an outstanding amount?In coupon bonds, the paid price incorporates the future coupons. A regular loan from a bank to a customer usually resembles the purchase of the bond at a discount.Thanks,G

You should ask yourself what the bank loses at the moment the bond defaults: All remaining coupons and the principal amount discounted to the moment of default.Google found this:http://www.garp.org/media/489989/credit ... s.pdfSlide 8 - EAD defined as the exp. value of the loan at default.

Thanks a lot, Tad. But somehow I have more questions than before.GARP notes mention the expected value of the loan at the time of default. Naive question number 1:What is the definition of the expected value of the loan? Is it a loan value discounted with expected return (not the contractual one)?Naive question number 2:Which interest rate do you use for discounting? I mean how do you establish the value of the loan with a specific counter-party (a loan that you purchased at the discount)?For example: a bank gave a loan to a customer, 96USD and 1 year the customer should return 100USD.What is the exposure at the beginning (the first day of the loan)? Is it 96 or 100? The implied continuously compounded interest rate is 6.187%. What happens say in half year? How do I establish the interest rate?G

Sorry for the confusion. By "discounted to the moment of default" I simply meant the fair value of the bond at that time. This will be, for example, the market value at which the bond is traded on an exchange.In your example it would be 96 all else equal and assuming that 96 is the current fair value.Concerning the interest rates you should look up how bonds and loans are priced..

Thanks.