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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank allocates economic capital to two units using stand-alone capital. Unit A has stand-alone economic capital of 60 million and Unit B has 40 million. The bank-wide economic capital, reflecting diversification, is 80 million. Under a simple pro-rata allocation of the diversified total in proportion to stand-alone capital, how much is allocated to Unit A?

Unit A receives 48 million. Its share of stand-alone capital is 60 of 100, or 60 percent, and applying that to the diversified bank-wide capital of 80 million gives 48 million. Using 60 million would ignore the diversification benefit.

  1. A60 million
  2. B48 millionCorrect
  3. C40 million
  4. D52 million

Explanation

Proportion for A = 60/(60+40) = 0.60. Allocation = 0.60 x 80 = 48 million. Using 60 million ignores the diversification benefit of 20 million. Allocating the benefit equally would give 50 million, and 40 million is B's stand-alone figure.

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