qingshu

 

AIM 3: Define and compare the six methods of allocating economic capital.

1、Which of the following methods of allocating economic capital uses a bottom-up approach?

A) Internal betas method.

B) Marginal capital method.

C) Arbitrage pricing theory (APT) method.

D) Scaling method.

qingshu

 

The correct answer is D

The scaling method of capital allocation is a bottom-up approach. This method calculates economic capital for a homogeneous portfolio that corresponds to an appropriate business unit.

qingshu

 

2、Which of the following models of capital allocation estimates the economic capital for a bank and then estimates the economic capital that would be needed without a particular business unit?

A) RAROC-based proportional scaling rule.

B) Incremental capital allocation rule.

C) Fair value allocation rule.

D) Stand-alone method.

qingshu

 

The correct answer is B

The incremental capital allocation rule attempts to assess the economic capital required for a bank and then estimate what the economic capital that would be needed without one of the business units. The ratio of each business unit’s marginal capital divided by the aggregate marginal capital gives an estimate of the fraction of economic capital to assign to the business unit.

qingshu

 

3、Of the six methods of allocating economic capital, the one that explicitly incorporates a VAR methodology is the:

A) incremental capital allocation rule. 

B) fair value allocation rule. 

C) RAROC-based proportional scaling rule.

D) stand-alone, market-based allocation rule. 

qingshu

 

The correct answer is B

The fair value method or “fair value allocation rule” measures the net asset value of each business unit “j” (NAVj) using discounted cash flow or some other approach. Then the method requires two values: 1) an estimate of the volatility of the NAVj over the designated horizon and 2) an appropriate confidence level. The economic capital for each unit is essentially the value at risk (VAR) of the NAVj given the two inputs. “RAROC-based proportional scaling rule” is not the best answer because the calculation may be based on VAR or some other bottom-up methodology.

qingshu

 

4、Of the six methods of allocating economic capital, the one that is bottom-up in nature is the:

A) RAROC-based, proportional scaling method.

B) stand-alone, market-based allocation method.

C) incremental capital allocation method.

D) fair value allocation method.

qingshu

 

The correct answer is A

The RAROC-based proportional scaling method uses a bottom-up process to calculate economic capital for homogeneous portfolios corresponding to the business units.

qingshu

 

AIM 4: Explain how liquidity and information affect strategic capital allocation.

The selling of liquid positions by banks is:

A) legal but not recommended.

B) legal and recommended.

C) illegal.

D) None of the above.

qingshu

 

The correct answer is B

Having only illiquid assets on the balance sheet allows the bank to focus on those types of assets