FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks
A bank allocates economic capital to two units. Unit A earns net income of 30 million after expected losses on allocated EC of 200 million. Unit B earns 24 million on allocated EC of 120 million. The hurdle rate is 16%. Which conclusion is correct using RAROC-style comparison?
Only Unit B exceeds the hurdle. Unit A's return on economic capital is 30/200 = 15%, below 16%, while Unit B earns 24/120 = 20%. Absolute income is irrelevant to the comparison; return per unit of allocated capital matters.
- ABoth units exceed the hurdle; A has the higher return
- BOnly A exceeds the hurdle
- CNeither unit meets the hurdle
- DOnly B exceeds the hurdleCorrect
Explanation
A: 30/200 = 15%, below 16%. B: 24/120 = 20%, above 16%. Thus only B clears the hurdle, although A has larger absolute income.
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