LGD Calculator – Loss Given Default

With this LGD calculator, we are here to help you calculate a company's loss given default. Loss given default (LGD) is an important concept to understand, especially when analyzing a company's credit quality. In particular, it tells you how much money you will lose if the company you invest defaults on its debt.

We wrote this article to help you understand what is LGD and how to calculate LGD. To facilitate you in understanding the concept, we will also demonstrate a loss given default example. But before we dive into the calculation, we will start with explaining the LGD's meaning.

LGD, which stands for loss given default, represents the amount of money you risk losing if the company you invest in goes bankrupt. It is a valuable metric in assessing the credit risk of a company before investing in it.

Unlike other liquidity ratios, such as the current ratio and credit spread, which tell you the company's financial position and how likely it will default, the LGD calculates how much you will lose if a credit event does actually happen. To understand more on these metrics, check out our current ratio calculator and credit spread calculator. This metric can help you to understand the worst-case scenarios of your portfolio.

Now that we have understood what LGD is, we can look at how to use this metric in a loss given default example.

We will examine an investment in Company Alpha as our loss given default example to help you understand how to calculate the loss given default.

Company Alpha reports the following information:

• Company name: Company Alpha
• Recovery rate: 80%
• Loss severity: 20%
• Expected exposure in Company Alpha: $1,000,000

1. Determine the recovery rate or loss severity.

   The first step is to understand the relationship between recovery rate and loss severity. Their relationships are depicted as the following formula:

   recovery rate = 1 - severity

   or

   loss severity = 1 - recovery rate

   To proceed with the calculation, we need to have at least one of them. In this example, we assume the recovery rate of 80%, hence loss severity of 20%.

2. Determine the expected exposure.

   The next step is to determine the expected exposure. The expected exposure can be interpreted as the amount of investment you put into your investment. For our example, the expected exposure in Company Alpha is $1,000,000.

3. Calculate the loss given default (LGD).

   The final step is to calculate the LGD. We can do this by using the following formula:

   LGD = expected exposure × loss severity

   or

   LGD = expected exposure × (1 - recovery rate)

   In the example, the LGD of the Company Alpha is:

   $1,000,000 × 20% = $200,000.

After we understand what loss given default is, we can now discuss why it is useful:

• Advantage: The most prominent use for calculating LGD is allowing you to understand how much money you can probably lose in the investment, i.e., it tells you the worst-case scenario. Thus, it can help to assess if the LGD is a loss that you can possibly stomach.

• Disadvantage: However, the LGD does not tell you the probability of the company going default. One investment may have a small LGD but a high probability of default and vice versa. This scenario can make LGD an interior metric to assess investment risks.