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2、A bank loan has expected gross revenue of $300,000, interest expense of $200,000, expected return on the $200,000 of economic capital of $20,000, expected loss on the loan of $10,000 and operating costs associated with the loan of $70,000. What is the risk adjusted return on capital (RAROC) for this loan?

A) 20%.
 
B) 10%.
 
C) 30%.
 
D) 55%.
 

nayizhenfeng

The correct answer is A

RAROC = (300 ? 200 ? 10 + 20 ? 70) / 200 = 20%.

nayizhenfeng

AIM 3: Explain how capital is attributed to market, credit, and operational risk.

 

1、What is the major source of market risk for a bank?

A) Credit risk.
 
B) Gap risk.
 
C) Operational risk.
 
D) Exchange rate risk.

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2、A credit institution is allowed to reduce its total operating risk charge by up to 20% through the use of insurance if it adopts the:

A) basic indicator approach (BIA).
 
B) advanced measurement approach (AMA).
 
C) advanced standardized approach (ASA).
 
D) standardized approach (SA).

nayizhenfeng

The correct answer is B

A credit institution is allowed to reduce its total operating risk charge by up to 20% through the use of insurance if it adopts the advanced measurement approach (AMA).

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AIM 4: Compute the capital charge for market risk and credit risk.

 

1、Given the following information what is the daily RAROC charge for market risk?

The appropriate adjustment factor for the day-to-day event risk that is not captured by the VAR model is 2.25.
The multiplier used to determine the unused portion of the VAR limit is 0.30.
The mulitiplier used to determine the charge for exceeding the VAR limit is 3.20.
The VAR limit over a 10-day period is $2,530,000.
The daily VAR is $950,000.
A) $3,040,000. 
 
B) $1,100,000. 
 
C) $2,587,500. 
 
D) $2,617,500. 

nayizhenfeng

The correct answer is D

The RAROC capital charge = F1(VAR) + F2(VAR limit – VAR) + F3 (VAR – VAR limit)

Where:
F1 = constant that adjusts for day to day event risk not captured in the VAR model
F2 = the multiplier used to determine the unused portion of the VAR limit
F3 = the multiplier used to determine the charge for exceeding the VAR limit

The question asks for the daily RAROC charge, so we need to first convert the 10-day VAR limit to a daily limit. $2,530,000 / √10 = $800,000

Thus the RAROC capital charge is:

2.25($950,000) + 0 + 3.20($950,000 - $800,000) = $2,617,500.

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2、Calculate the RAROC capital charge for market risk assuming:

The appropriate adjustment factor for the day-to day event risk that is not captured in VAR is 3.
The multiplier used to determine the charge for the unused portion of the VAR limit is ?0.20.
The multiplier used to determine the charge for exceeding the VAR limit is 5.
The VAR limit is $10 million.
VAR is $9 million.
A) $28,200,000.
 
B) $30,200,000.
 
C) $26,800,000.
 
D) $435,200,000.

nayizhenfeng

The correct answer is C

RAROC capital charge = 3($9 million) + (?0.20)($1 million) + 5($0) = $26,800,000.

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AIM 6: Explain how the second-generation RAROC approaches improve economic capital allocation decisions.

 

1、The flaw in the first-generation risk-adjusted return on capital (RAROC) approach is that it:

A) assumes that the default probability remains constant.
 
B) attempts to align the risk of the business with the firm’s equity. 
 
C) only estimates the RAROC hurdle rate.
 
D) is poorly understood by investors and directors.