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

Why do many banks adjust the RAROC numerator for the capital benefit, and the hurdle for systematic risk, such as using a CAPM-based adjusted RAROC?

Banks use a CAPM-based adjusted RAROC so the hurdle reflects each unit's systematic risk. Shareholders can diversify specific risk, so comparing RAROC with a beta-based required return aligns performance measurement with the return investors actually demand.

  1. ATo make RAROC comparable with the shareholders' required return, since the CAPM hurdle reflects only the systematic (non-diversifiable) risk of the unitCorrect
  2. BTo eliminate the need for economic capital
  3. CTo ensure all units have identical RAROC
  4. DTo remove expected losses from the calculation

Explanation

Standard RAROC compares return to a single bank-wide hurdle, ignoring that units differ in systematic risk. Adjusted RAROC compares RAROC to a hurdle based on beta, aligning with shareholders' required return for that unit's non-diversifiable risk.

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