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

A bank ranks two units. Unit A has RAROC of 20% on capital of $100 million; Unit B has RAROC of 15% on capital of $400 million. The hurdle rate is 12%. A manager argues Unit A should receive priority because its RAROC is higher. Which analysis best reflects shareholder value creation?

Unit A's EVA is 8% of $100 million, or $8 million, while Unit B's is 3% of $400 million, or $12 million. EVA reflects the size of capital employed, so Unit B adds more absolute shareholder value even though its RAROC ratio is lower.

  1. AUnit B creates more EVA ($12 million vs $8 million), so absolute value added favors Unit B despite its lower RAROCCorrect
  2. BUnit A creates more EVA because its RAROC is higher, at $20 million
  3. CUnit B destroys value because its RAROC is below Unit A's
  4. DBoth units have identical EVA because both exceed the hurdle

Explanation

Unit A EVA = (20%-12%) x 100 = $8 million. Unit B EVA = (15%-12%) x 400 = $12 million. EVA captures scale, while RAROC is a ratio. The $20 million option is the RAROC dollar return, not EVA. A lower RAROC above hurdle still creates value.

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