K-Life financial services Limited uses risk-adjusted return on capital (RAROC) to measure performance on several aspects. In this regard, imagine that an investment officer wants to execute a transaction with the following characteristics: Probability of default (PD) = 30 basis points Loss given default (LGD) = 55% Exposure at default (EAD) = K 1.45 million Expected loss (EL) = K 2,750 This is a loan to a company in the Agro industrial. The firm’s economic capital (EC) model is based on the 99% confidence level, with an average standard deviation of 2.15%. The risk-free rate of return is 6%. Assume that the bank has set a RAROC hurdle rate of 15% and this transaction has a net profit of K10, 500. REQUIRED: Compute the K-life’s risk-adjusted rate of return on this transaction. Now assume that K-life could also have made a loan for the same amount to a firm in the service industry, and that the standard deviation for economic capital purposes in this case is 1.29%. Compute the bank’s risk-adjusted rate of return on this transaction? Which loan between the two entities should the K-life grant and why?
K-Life financial services Limited uses risk-adjusted return on capital (RAROC) to measure performance on several aspects. In this regard, imagine that an investment officer wants to execute a transaction with the following characteristics: Probability of default (PD) = 30 basis points Loss given default (LGD) = 55% Exposure at default (EAD) = K 1.45 million Expected loss (EL) = K 2,750 This is a loan to a company in the Agro industrial. The firm’s economic capital (EC) model is based on the 99% confidence level, with an average standard deviation of 2.15%. The risk-free rate of return is 6%. Assume that the bank has set a RAROC hurdle rate of 15% and this transaction has a net profit of K10, 500. REQUIRED: Compute the K-life’s risk-adjusted rate of return on this transaction. Now assume that K-life could also have made a loan for the same amount to a firm in the service industry, and that the standard deviation for economic capital purposes in this case is 1.29%. Compute the bank’s risk-adjusted rate of return on this transaction? Which loan between the two entities should the K-life grant and why?
Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Chapter5: Risk Analysis
Section: Chapter Questions
Problem 14PC: Refer to the financial state-ment data for Abercrombie Fitch in Problem 4.25 in Chapter 4. Exhibit...
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K-Life financial services Limited uses risk-adjusted return on capital (RAROC) to measure performance on several aspects. In this regard, imagine that an investment officer wants to execute a transaction with the following characteristics:
- Probability of default (PD) = 30 basis points
- Loss given default (LGD) = 55%
- Exposure at default (EAD) = K 1.45 million
- Expected loss (EL) = K 2,750
This is a loan to a company in the Agro industrial. The firm’s economic capital (EC) model is based on the 99% confidence level, with an average standard deviation of 2.15%.
The risk-free
Assume that the bank has set a RAROC hurdle rate of 15% and this transaction has a net profit of K10, 500.
REQUIRED:
- Compute the K-life’s risk-adjusted rate of return on this transaction.
- Now assume that K-life could also have made a loan for the same amount to a firm in the service industry, and that the standard deviation for economic capital purposes in this case is 1.29%. Compute the bank’s risk-adjusted rate of return on this transaction?
- Which loan between the two entities should the K-life grant and why?
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