B
BhatiaI
Member
Hi Colin,
Thank you for being patient with my never ending questions, here is another one on VaR and Capital allocation
April 2005 Ques. Paper
Ques. 1 part iii
The question says calculate allocated capital and solved it using EAR, which is fine.
But we can calculate using RAROC too, right? That is the calculation I need to discuss:
RAROC=Revenue-cost-"Expected Loss"/VaR
SO we can say, allocated capital=Revenue-cost-Expected Loss/RAROC=
Mortgage Lending
Revenue=30
Expected Annual cost=20m
Expected loss=1m
Target return on capital=10%
Capital = (30-20-1)/10%=90m.
Do you agree?
Secondly, the question says 95% VaR for Mortgage lending =0, does that mean there is no loss ie downside risk for Mortage lending at 95th %ile? Does not sound intuitive to me or I am missing something?
Thirdly, in chapter 13, question 13.2 I am unable to follow, which is dealing with net and gross measure.
Lastly, the old version of ques. bank part 4, ques. 1 part 1 says "
This is typically done using a measure such as:
(Revenues RAROC costs 'expected' losses)
VaR
Revenues would be the typical annual revenue from the business line.
Costs would be the costs incurred in managing that business. It is often better to include
the “cost of capital” in this item as well, particularly where one business line (such as
loans) requires capital to be invested and the other (futures dealing) requires no lending
of capital.
So in the case of the bank in question we would include “capital invested ¥ cost of
capital” as part of the costs of the loan business, whereas the futures business would
only have the physical costs of running the business such as salaries and rents etc."
My question is following from the previous part discussion of Gross and Net measure, "Capital Invested*Cost of capital", should this not be capital ALLOCATED and should be for both Bank and futures business as both need capital allocated?
Thanks in advance for your help.
Kind Regards
ishita
Thank you for being patient with my never ending questions, here is another one on VaR and Capital allocation
April 2005 Ques. Paper
Ques. 1 part iii
The question says calculate allocated capital and solved it using EAR, which is fine.
But we can calculate using RAROC too, right? That is the calculation I need to discuss:
RAROC=Revenue-cost-"Expected Loss"/VaR
SO we can say, allocated capital=Revenue-cost-Expected Loss/RAROC=
Mortgage Lending
Revenue=30
Expected Annual cost=20m
Expected loss=1m
Target return on capital=10%
Capital = (30-20-1)/10%=90m.
Do you agree?
Secondly, the question says 95% VaR for Mortgage lending =0, does that mean there is no loss ie downside risk for Mortage lending at 95th %ile? Does not sound intuitive to me or I am missing something?
Thirdly, in chapter 13, question 13.2 I am unable to follow, which is dealing with net and gross measure.
Lastly, the old version of ques. bank part 4, ques. 1 part 1 says "
This is typically done using a measure such as:
(Revenues RAROC costs 'expected' losses)
VaR
Revenues would be the typical annual revenue from the business line.
Costs would be the costs incurred in managing that business. It is often better to include
the “cost of capital” in this item as well, particularly where one business line (such as
loans) requires capital to be invested and the other (futures dealing) requires no lending
of capital.
So in the case of the bank in question we would include “capital invested ¥ cost of
capital” as part of the costs of the loan business, whereas the futures business would
only have the physical costs of running the business such as salaries and rents etc."
My question is following from the previous part discussion of Gross and Net measure, "Capital Invested*Cost of capital", should this not be capital ALLOCATED and should be for both Bank and futures business as both need capital allocated?
Thanks in advance for your help.
Kind Regards
ishita