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

A bank uses RAROC = (revenues - costs - expected losses) / economic capital, with a hurdle rate of 12%. Unit X: net revenue after costs 60, expected loss 10, allocated capital 400 on a stand-alone basis. After switching to a diversified allocation, unit X's capital falls to 300. Which conclusion is correct?

RAROC moves from 12.5 percent (50/400) to 16.7 percent (50/300). Earnings after expected losses are unchanged at 50, so the improvement stems purely from the capital allocation method, which illustrates how attribution choices can alter performance rankings and hurdle-rate decisions.

  1. ARAROC rises from 12.5% to 16.7%, so the unit looks more attractive only because of the allocation method, not because performance changedCorrect
  2. BRAROC rises from 15.0% to 20.0%, reflecting real value creation
  3. CRAROC falls from 12.5% to 16.7% because capital declined
  4. DRAROC is unchanged because earnings are unchanged

Explanation

Numerator = 60 - 10 = 50. Stand-alone RAROC = 50/400 = 12.5%; diversified = 50/300 = 16.7%. Earnings did not change; only the denominator did. Option 15% and 20% wrongly use 60 without deducting expected loss. This shows RAROC sensitivity to attribution method.

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