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FRM Part II · FRM Exam Part II · Capital Regulation Before the Global Financial Crisis

A bank holds a 5-year interest rate swap with notional $200 million and a current replacement cost (positive mark-to-market) of $3 million. Under the Basel I current exposure method, the add-on factor for interest rate contracts with maturity of one to five years is 0.5%. The counterparty is a corporate with a 100% risk weight. What is the capital required for this swap at 8%?

The credit equivalent amount is the $3 million replacement cost plus a $1 million add-on (0.5% of $200 million), totalling $4 million. At a 100% risk weight and 8% capital ratio, required capital is $0.32 million. Ignoring the add-on gives the wrong $0.24 million.

  1. A$0.32 millionCorrect
  2. B$0.24 million
  3. C$0.08 million
  4. D$0.40 million

Explanation

Credit equivalent = current exposure + add-on = 3 + 0.005×200 = 3 + 1 = $4 million. RWA = 4 × 100% = $4 million. Capital = 8% × 4 = $0.32 million. Omitting the add-on gives $0.24 million.

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