The likelihood that a borrower will fail to pay within a stated period, usually a year. It is one of the three inputs to expected loss.
Where you will meet it
Probability of default comes up in 119 learning outcome notes across the FRM syllabus.
A few of them:
Banks FRM Part I · Financial markets and products
“A 99.97% level corresponds to a default probability of 0.03%, which is only illustratively about an AA rating, because the mapping depends on the agency and the horizon.”
The Building Blocks of Risk Management FRM Part I · Foundations of risk management
“For credit, the formula is EL = PD × LGD × EAD.”
Fundamentals of Probability FRM Part I · Quantitative analysis
“For a bond that has survived so far, default in a later period is conditional on that survival, so divide the unconditional probability of default in that period by the survival probability, not by one.”
External and Internal Credit Ratings FRM Part I · Valuation and risk models
“Each grade is linked to default probability through long-run historical default rates, which rise steeply as the rating falls.”
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