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

A bank's equity-trading unit earns revenues of $60 million, incurs operating costs of $20 million and expected losses of $10 million, and receives a $5 million capital benefit credit. It is allocated $200 million of economic capital. Using the standard RAROC definition (risk-adjusted return after expected losses, divided by economic capital), what is the unit's RAROC?

RAROC is 17.5%. Revenues less costs and expected losses, plus the capital benefit, give $35 million of risk-adjusted return, which divided by $200 million of economic capital equals 17.5%. Leaving out the capital benefit would understate it at 15%.

  1. A15.0%
  2. B17.5%Correct
  3. C20.0%
  4. D12.5%

Explanation

Risk-adjusted return = 60 - 20 - 10 + 5 = 35. RAROC = 35/200 = 17.5%. Omitting the capital benefit gives 15.0%, which understates the return because the unit's capital earns a risk-free credit.

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