Capital charge

[Imad]

Hi David,

How are you?
Would you please elaborate more the notion of capital charge. I came across different definitions such as "the cost to a company of borrowing money", "a monetary amount, calculated by multiplying the money the business has tied up in capital, by the weighted average cost of capital (WACC)" and "the amount of money shareholders require each year in return for providing financing to a business".

Which one is correct?

Thanks
Imad

 

[ShaktiRathore]

See above definitions have their own significance that is they are defined in different contexts, for example the definition "a monetary amount, calculated by multiplying the money the business has tied up in capital, by the weighted average cost of capital (WACC)" is related to capital required by bank to face losses. http://www.ventureline.com/accounting-glossary/C/capital-charge-definition/
capital charge as "the amount of money shareholders require each year in return for providing financing to a business" is the required rate by shreholders for bearing the risk of investing in the business.
capital charge as "the cost to a company of borrowing money" is the debt charge which company needs to pay while borrowing.
See definitions in diffferent contexts and dont get confused..
thanks

 

[David Harper CFA FRM]

Hi Imad, I agree (with Shakti) that it can have various meanings with respect to capital providers (shareholders & creditors). And, also, value-based measures (e.g., in EVA, it could be economic capital * WACC). So, i don't think in these context that is sufficiently precise to standalone.

However, for the FRM, it tends to have a meaning. When I first clicked on your thread, I expected a query about the Basel II/III capital charge. This is the regulator capital (i.e., Tier 1 or qualifying Tier 2 regulatory required for an exposure). The classic FRM exam question is something like: if a $10 MM loan has a risk weight of 50%, what is Basel's SA credit approach capital charge? Answer: $10 MM*50%*8% = $400,000 capital charge (aka, capital requirement). Two links with further detail, I hope that helps thanks,

• http://forum.bionicturtle.com/threads/the-capital-requirement-k.5884/#post-18119
• http://forum.bionicturtle.com/threa...ngle-risk-factor-operational.2136/#post-17200