RWA

[dlrm]

15.6 Estimate the capital required under Basel I for a bank that has the following transactions with a corporation. Assume no netting.
a. A nine-year interest rate swap with a notional principal of $250 million and a current market value of −$2 million.
b. A four-year interest rate swap with a notional principal of $100 million and a current value of $3.5 million.
c. A six-month derivative on a commodity with a principal of $50 million that is currently worth $1 million.

The risk-weighted assets for the three transactions are (a) $ 1.875 million, (b) $ 2 million, and (c) $ 3 million for a total of $ 6.875 million. The capital required is 0.08 × 6.875 or $ 0.55 million.
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Could you please explain this calculations. For example, for (a) - for 9y int.rate swap we use addon factor 1.5%, so we have RWA=250*0.015=3.75, why the answer is 1.875?

 

[David Harper CFA FRM]

Hi @dlrm See below (my XLS is here https://www.dropbox.com/s/s4jsafh0jamvnue/0825-hull-15-6.xlsx?dl=0; a new version of this study note will be published soon)
... you are just missing the final multiplication by 0.5; i.e.,

"The credit equivalent amount arising from either the second or third category of exposures is multiplied by the risk weight for the counterparty in order to calculate the risk-weighted assets. The risk weights are similar to those in Table 15.1 except that the risk weight for a corporation is 0.5 rather than 1.0." -- Hull, John C.. Risk Management and Financial Institutions (Wiley Finance) (p. 329). Wiley. Kindle Edition.

I hope that's helpful!

 

[[email protected]]

Hi David,

I am struggling with Hull's own question.

For (b) and (c) I get:

Max(3.5m,0) + 0,5 (corporate) * 0,005 (4 year maturity IRS) * 100m notional = RWA = 75m

Max(1m,0) + 0,5 (corporate) * 0,10 (6m commodity) * 50m notional = RWA = 3,5m

Can you help me understand where I am going wrong?

Thanks

5.6 Estimate the capital required under Basel I for a bank that has the following transactions with a corporation. Assume no netting. a. A nine-year interest rate swap with a notional principal of $250 million and a current market value of −$2 million. b. A four-year interest rate swap with a notional principal of $100 million and a current value of $3.5 million. c. A six-month derivative on a commodity with a principal of $50 million that is currently worth $1 million.

The risk-weighted assets for the three transactions are (a) $ 1.875 million, (b) $ 2 million, and (c) $ 3 million for a total of $ 6.875 million. The capital required is 0.08 × 6.875 or $ 0.55 million.

 

[David Harper CFA FRM]

Hi @[email protected] looks like I worked this out in the exhibit above last year. See above. I hope this helps!

 

[[email protected]]

Thanks David. I can see that I needed to bracket everything apart from the counterparty rating (0,5).

 

[FRM candidate]

Hi David,
I'm not sure how the risk weights in 15.6 are calculated. I'm using this formula: max(V, 0) + a × L and applying the following add on factors


a) 0.015*250 = 3.75
b) 0.005*100 + 3.5 = 4
c) 0.1*50 +1 = 6

then I am using the table below to get the relevant risk weight for a corporation and get the following values for the RWA
a) 100%* 3.75 = 3,75
b) 100%*4 = 4
c) 100%*6 = 6

where am I going wrong?

 

[David Harper CFA FRM]

@FRM candidate You posted this in T7.517, where it doesn't seem to directly relate, I don't know to what question you are referring (15.6?)

 

[FRM candidate]

it's in HULL, CHAPTER 15: BASEL I, II, AND SOLVENCY II, HULL, CHAPTER 15: END OF CHAPTER Q&A

 

[David Harper CFA FRM]

@FRM candidate okay, then I've moved your question to a pre-existing thread where I've not only answered the question, I created a spreadsheet (see above) for it! To be honest, it has taken me almost more time to figure out what you are asking and locate the pre-existing answer than it was to answer the original question. Please note that we even have a tag for this question: https://forum.bionicturtle.com/tags/hull-rmfi-15-6/
.... it's totally fine, me and @Nicole Seaman are sincerely here to help, we would just appreciate if you try to use the forum in a way that "helps us help you" starting with your original post that didn't really tell me exactly where the question was. I am currently on a flight from LAX to Austin, to illustrate how time-intensive support can be for us, so we'd appreciate your cooperation. Thanks!