Fran
Administrator
Questions:
300.1 To calculate its risk-adjusted return on capital (RAROC), your bank uses a capital charge of 4.00% for long-term credit commitments with a loan equivalent factor (LEF) of 0.50 assigned to the undrawn portion. Stress testing suggests the LEF may be too low during economic downturns. You recommend an increase in the LEF to 0.85. For a facility that has an original principal of USD 1.0 billion and is 20.0% drawn, how much additional economic capital will be allocated if there is an increase in the loan equivalent factor (LEF) from 0.50 to 0.85? (this is inspired by GARP's sample exam question 2013.P2.19)
a. $11.2 million
b. $35.0 million
c. $70.0 million
d. $210. million
300.2 A proposed $3.0 billion loan portfolio that earns an average of 6.0% per annum will be funded by an equivalent amount of deposits (liabilities) that pay depositors an average of 2.0% per annum. Equity held against the loan portfolio will be 8.0%, or $240.0 million, which is also the amount of economic capital (EC). This equity will be invested in safe U.S Treasuries with an expected return of only 1.0%. The expected loss on the loan portfolio will be 2.0%. The operating costs allocated to the portfolio will be $27.0 million. You computed the RAROC and your manager recommended going forward with the loan project, but the Risk Committee asks if the loan project is still advisable under an adjusted RAROC methodology (ARAROC). If the risk-free rate is 1.0%, the expected excess market return is 8.0%, and the project's equity beta is 1.60 (i.e., significant systemic exposure), is the project advisable under an ARAROC approach?
a. No, ARAROC is only 4.4%
b. No, ARAROC is only 5.1%
c. Yes, ARAROC is about 6.8%
d. Yes, ARAROC is about 10.5%
300.3. You are reviewing your firm's regular assessment and report of economic capital (EC) to the Board's Risk Committee. The report unfortunately contains three understandable but false assumptions. Each of the following is false except which statement is TRUE?
a. As an EC risk metric, expected shortfall (ES) dominates value at risk (VaR) in every BIS category (intuitive, stable, easy to compute, easy to understand, coherent; and meaningful decomposition)
b. When aggregating component risks up to the firm-wide EC, the upper bound on the aggregated risk should be the sum of individual components (correlation of 1.0).
c. Consistent with regulations, economic capital must be calibrated to a minimum of 99.9% confidence and a one-year horizon
d. Economic capital can be either greater or less than regulatory capital
Answers:
