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FRM Part II · FRM Exam Part II · Integrated Risk Management

A bank has firm-wide economic capital of USD 200 million. Removing a trading desk would reduce firm-wide economic capital to USD 150 million. The desk's standalone economic capital is USD 70 million. A manager argues the desk should be charged its standalone capital. Which statement is correct?

The desk's incremental capital is USD 50 million, the drop in firm-wide capital from 200 to 150 if it is removed. This is below its standalone USD 70 million because diversification with other businesses lowers its marginal contribution to total risk.

  1. AThe desk's incremental capital is USD 50 million, which reflects its diversification benefit and is lower than its standalone capitalCorrect
  2. BThe desk's incremental capital is USD 70 million, equal to standalone
  3. CThe desk's incremental capital is USD 150 million
  4. DThe desk's incremental capital is USD 20 million, the diversification benefit

Explanation

Incremental capital = 200 − 150 = 50 million. It is below the standalone 70 million because the desk diversifies with other business. The 20 million figure is the diversification benefit (70 − 50), not the incremental capital.

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