Capital Allocation and RAPM by Edu Pristine

Author of lecture Capital Allocation and RAPM

Edu Pristine

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... in a Financial Institution. Define and Describe the different types of capital. Demonstrate Economic Capital. Describe the different approaches to calculating Economic ...

... metric for aggregating different risks viz. the credit, market and operational risk. Credit risk: fall in value of a portfolio due to default or a downgrade of a borrower. Market risk: fall in value of a ...

... estimate of the level of capital that a firm requires to operate its business with a desired target solvency level. Also referred to ...

... EC is defined to absorb only unexpected losses (UL) up to a certain confidence level (i.e., A0 (l - u )). Credit reserves are traditionally set ...

... Capital. Economic capital is the minimum amount of capital essential to sustain losses. ...

... capital required for the firm if the value of assets equal to the market value of liabilities. Scenario 2: Given a 0.5% worse case scenario the firm has a ...

... Economic Capital example. Solution. Scenario 1: The economic capital required will be ...

... riskiness of the earnings. Limitations: It requires historical performance data for reliable estimates of the mean and standard deviation of earnings, which may not be easily available. It does not link EC directly to the sources of risk. ...

... Assumes that the market value of capital can be modelled as a call option on the value of the firm’s assets where the strike price is the notional value of the debt. An advantage ...

... a firm might use an internal VaR model for market risk, a credit VaR methodology for credit risk and a loss-distribution approach for operational risk. Then, at the second level, the firm must consolidate the capital across these risks. Total capital estimation: First Method: Add up the credit risk capital, market ...

... of one or several catastrophic scenarios and portfolio losses are determined based on these scenarios. Enterprise Capital Practices: When each type of risk is modelled separately and the economic capital is assigned to each risk, the firm needs to make assumptions ...

... steps to implement them through detailed arrangements that are best suited to their jurisdiction. Main motivations that justify the existence of banking regulation are as follows: - Protection of banks’ depositors in the event of bank default To ensure ...

... banks to immunize against financial losses. Implementation of Basel-I started in 1992. Promote safety and soundness of the global financial system Uniform standards for international active banks around the world At ... overall risk Introduction to stress testing, concentration risk and residual risk on products such as credit derivatives Supervisor’s view Pillar III Market Discipline Disclosure to all the ...

... 16 Capital Allocation. EC allocation down to portfolio is essential: Management ...

... to capture an appropriate amount of risk capital that the unit contributes to the entire firm’s capital requirements. Calculated by taking the EC computed for the entire firm and subtracting from it EC for the firm without the business unit or sub-portfolio. Captures exactly the amount of capital that would be released if the ...

... both the portfolios on returns basis we would actually go for investing in A. But on risk basis which ...

... thus become an ideal tool for capital allocation purposesv. Two broad classes of RAPM measures include. Risk-adjusted return on capital (RAROC) - applies the risk ...

... of Risk Adjusted Performance Measure that standardizes performance measurement for different transactions. It incorporates economic capital attributed in the denominator (grain Facility level) for the analyses. RAROC measure requires revenue inputs from Funds ...

... of Default 3% Loss Given Default 55% Cost Attributed (Input) $925 Risk Free Rate 5% Capital Attributed $1,526 ...