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

A trading desk earns net income of $30 million on allocated economic capital of $250 million. The bank's cost of equity is 10%. A risk manager computes RAROC as net income divided by economic capital. Which statement correctly compares RAROC with the hurdle rate and the implied EVA?

RAROC is 30/250 = 12%, which is above the 10% hurdle. EVA equals the spread of 2% times the $250 million of capital, which is +$5 million. A RAROC above the hurdle rate always corresponds to positive EVA, so the desk adds shareholder value.

  1. ARAROC is 12%, exceeding the hurdle, and EVA is +$5 millionCorrect
  2. BRAROC is 12%, exceeding the hurdle, and EVA is +$25 million
  3. CRAROC is 8.3%, below the hurdle, and EVA is -$5 million
  4. DRAROC is 12%, exceeding the hurdle, and EVA is -$5 million

Explanation

RAROC = 30/250 = 12%. Capital charge = 10% x 250 = $25 million, so EVA = 30 - 25 = +$5 million. Equivalently EVA = (RAROC - hurdle) x capital = 2% x 250 = $5 million. The $25 million option confuses the capital charge with EVA.

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