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

A bank's standalone economic capital figures for its three business units are: Retail USD 200 million, Corporate USD 300 million, Trading USD 150 million. The bank's total economic capital, measured at the firm level, is USD 520 million. Which interpretation is correct?

The diversification benefit is USD 130 million. Standalone capital sums to USD 650 million, while firm-level capital is USD 520 million because unit losses are imperfectly correlated. The difference is the capital saved through diversification across businesses.

  1. AThe diversification benefit is USD 130 million, being the amount by which the sum of standalone capital (650) exceeds firm-level capitalCorrect
  2. BThe diversification benefit is USD 520 million, because total capital equals the diversified amount
  3. CThere is no diversification benefit since firm-level capital must equal the sum of standalone capital
  4. DThe diversification benefit is USD 70 million, being the firm capital minus the largest unit's capital

Explanation

Sum of standalone = 200+300+150 = 650. Firm-level capital of 520 is lower because losses across units are not perfectly correlated. Benefit = 650 - 520 = 130. The other options misuse the figures.

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