FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends
A firm has three business units whose stand-alone economic capital requirements are 40 million, 30 million and 50 million. The ERM team estimates that, because the units' losses are not perfectly correlated, the firm-wide economic capital is 96 million. What is the diversification benefit, and what percentage of the sum of stand-alone capital does it represent?
The diversification benefit is 24 million, or 20.0 percent. Stand-alone capital sums to 120 million, firm-wide capital is 96 million, so the difference is 24 million, and dividing by the 120 million sum gives 20 percent.
- A24 million, 20.0%Correct
- B24 million, 25.0%
- C20 million, 16.7%
- D26 million, 21.7%
Explanation
Sum of stand-alone capital = 40 + 30 + 50 = 120 million. Diversification benefit = 120 - 96 = 24 million. As a percentage, 24/120 = 20.0%. The 25.0% option divides by the firm-wide capital (24/96), which is the wrong base.
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