RAROC question in FRM Level 2

[Peter-Paul Hoogbruin]

Hey,

Peter from Atlanta here. There was a RAROC questions where a bank granted a loan with a 9% interest rate, 5% funding cost, 1% admin cost, 1% expected loss, a 3% investment return on economic capital (investing in Treasury paper) and 8% economic capital. I thought the RAROC would be (9% - 5% + 3%*8% -1% -1%) / 8% = 2.24% / 8% = 28%. However, this was not one of the choices (27% was). Any suggestions what I did wrong? Thanks.

 

[David Harper CFA FRM]

Hi Peter,

I get 28% also. You did it correctly per Crouhy. I input into XLS to check (column D):
http://sheet.zoho.com/public/btzoho/raroc-0523

The first column (column C) contains the original Crouhy approach (first print); Column C should not apply, it reflects the first print approach and this historical issue of whether deposits = assets.

Your approach (% only) implicity funds assets = deposits (so column D is invariant to loan size); the other (column C) has RAROC variant to loan size, so if the question omitted loan $, that further supports your approach IMO. If your assumes are correct, i too only see 28%

David

 

[Stucken]

Very interesting, because I also took the FRM level II exam and I had the same problem. As i can remember it was a two part question where the first part was to calculate only the risk adjusted return. And the following question was to calculate the final RAROC percentage. It was a pretty straightforward question which normally takes a minute or so. But in no way I arrived at one of the answers provided. So i had to basically guess those two questions while normally i would have both correct. I am confident that this is an error in the Level II exam, so I contacted GARP about this question. I hope to see their reply soon.