The formula to calculate the Loss Given Default (LGD) is:
\[ \text{LGD} = \text{Expected Exposure} \times \text{Loss Severity} \]
or equivalently:
\[ \text{LGD} = \text{Expected Exposure} \times (1 - \text{Recovery Rate}) \]
Loss Given Default (LGD) is a measure of the potential loss to an investor if a borrower defaults on a loan. It is calculated by multiplying the expected exposure by the loss severity (or one minus the recovery rate).
Let's assume the following:
Step 1: Calculate the loss severity:
\[ \text{Loss Severity} = 1 - \text{Recovery Rate} = 1 - 0.80 = 0.20 \]
Step 2: Calculate the Loss Given Default (LGD):
\[ \text{LGD} = \$1,000,000 \times 0.20 = \$200,000 \]
Therefore, the Loss Given Default is $200,000.
