RAROC

[[email protected]]

Hi David,

Good day!

I refer to the RAROC calculation example in 2008 study note, page 68/135. Just want to clarify on how the operation cost of 8mm is calculated? .

Btw, when the Market Risk study note is going to be released?

Cheers
Learning

 

[David Harper CFA FRM]

Hi chunleeng,

See errata: http://forum.bionicturtle.com/viewthread/615/
apologies, it's a typo, assumption is supposed to be 0.8% operating cost = $8 MM
(the operating cost, following Crouhy, will probably be given as an input, or expressed as %)

fyi, here is a RAROC question from sample exam: http://forum.bionicturtle.com/viewthread/1412/

Thanks, David

 

[dthigale]

Hi David,

Rather than adding a thread I will add my question in this thread. Hope it is okay and it works.

1. Will GARP explicitly indicate us in the FRM exam that the Economic Capital is not used from the loan portfolio? Else as you say, there is a chance of confusion.

In the example on page 10 of 7.a video tutorial, you have clearly given the implied balance sheet that gives a complete clarity on the application.

However, the earlier example on page 9 is bit confusing because the assumptions on EC is not specified.

A. If the Economic Capital (5 % / 50MM) is not used from the Loan Portfolio then the cost of financing will be 50MM and not 47.5 MM.

B. If the Economic Capital is used from the Loan Portfolio then the loan will earn interest on $ 950MM ie 66.5 MM.

Since you are earning interest on 1B portfolio (70MM) and also on the economic capital (8M) I suppose assumption A is correct. However then you must pay to all depositors...

Maybe I am missing something!

D.

 

[David Harper CFA FRM]

I hope they do, they should (I have certainly listed this potential confusion to GARP for 2+ years... )

...because you correct, how the EC is funded makes a difference
if you look @ http://www.bionicturtle.com/premium/spreadsheet/7.a.1_raroc_crouhy/
columns I and J show two versions of Crouhy (the assignment). His original print used v1 but the current print (perhaps based on confusions created here two years ago) resolved the problem with v2 (i.e., a "balanced" balance sheet)

here is from the sample question:
http://forum.bionicturtle.com/viewthread/1412/
...where you will not they state "appropriate credit-VaR for the loans is 7.5% " and they really should say "EC for the loans is 7.5%"
I just added the XLS for that sample problem (http://sheet.zoho.com/corporate/1978922/btzoho/e2-31b)
...and, correct me if i'm wrong, but the answer in that case does follow (19.33%) regardless

Thanks, David

 

[dthigale]

Hi David,

Thanks for your reply. The example you posted has different (for me complicated ) balance sheet.

What I thought was if 37.5 is funded by the loan portfolio then the bank will be able to loan only 462.5 and earn 10 % on that amount.

Also I noted that the bank is paying different interest rate ( 6 % and 6.5%) in two cases.

But overall I got the point.

Thank you so much for your prompt support and careful attention.

D.

 

[David Harper CFA FRM]

okay right, but i think the issue is the size of the loan portfolio (an asset)
in the question 31 example, if the loan portfolio is $500 then EC "invested in Gov't securities" must be additive so
assets = 500 + 37.5 = 537.5 regardless

then the issue is how is it funded (liabilities), either:
462.5 in deposits + 75 equity (original crouhy), or
500 in deposits + 37.5 equity (revised crouhy)

...if the loan portfolio is only $462.5, as you suggest as a scenario, i think that's like shrinking the B/S and will produce a higher RAROC. Then you'd have:
500 assets (462.5 loans + 32.5 treasuries) funded by
462.5 deposits + 32.5 equity

(the 6% and 6.5% i did to produce the same interest income from different deposit bases; so the RAROC is the same either way....)

...sorry to belabor, thanks David