AIM 5: Discuss the strengths and weaknesses of linking RAROC and EVA to develop a dynamic capital allocation model.

1、With respect to the development of a dynamic capital allocation model, which of the following is TRUE?

A) RAROC is a bottom-up approach, and EVA is a top-down approach.

B) RAROC is a top-down approach, and EVA is a bottom-up approach.

C) RAROC and EVA both use top-down approaches.

D) RAROC and EVA both use bottom-up approaches.

The correct answer is A

EVA is a top-down process, and the RAROC process is bottom-up. EVA uses market information, and RAROC relies more on accounting information.

2、A problem with linking EVA and RAROC in the development of a dynamic capital allocation model is that:

A) a fixed hurdle rate will lead banks to adopt countercyclical behavior.

B) EVA and RAROC are both bottom-up approaches, which lowers diversification.

C) None of the above.

D) a fixed hurdle rate will lead banks to adopt procyclical behavior.

The correct answer is D

EVA uses market information, and RAROC relies more on accounting information. This can produce problems such as procyclical behavior by banks if they measure RAROC with a fixed hurdle rate.

The correct answer is D

EVA uses market information, and RAROC relies more on accounting information. This can produce problems such as procyclical behavior by banks if they measure RAROC with a fixed hurdle rate.