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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank estimates the one-year portfolio loss distribution for its loan book. The mean (expected) loss is USD 40 million and the 99.9th percentile loss is USD 340 million. The bank defines economic capital as the amount needed to cover unexpected loss at that confidence level. What is the economic capital for this portfolio?

Economic capital is USD 300 million: the 99.9th percentile loss of USD 340 million minus the expected loss of USD 40 million. Expected loss is covered by pricing and reserves, so capital only needs to cover the unexpected portion of the loss.

  1. AUSD 40 million
  2. BUSD 300 millionCorrect
  3. CUSD 340 million
  4. DUSD 380 million

Explanation

Economic capital = percentile loss minus expected loss = 340 - 40 = USD 300 million. Using 340 ignores that expected loss is covered by pricing and provisions. Adding 40 gives the wrong sign.

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