nayizhenfeng

The correct answer is A

The flaw in the first-generation RAROC approach is that it assumes that the default probability remains constant. This assumption is inconsistent with a constant expected return on the firm’s equity.

nayizhenfeng

AIM 7: Compute the adjusted RAROC for a project to determine viability.

 

1、What is the adjusted RAROC for a business if its RAROC is 22%, the company’s beta is 1.1, and the risk-free rate is 5%?

A) 15.45%.
 
B) 17%.
 
C) 4.84%.
 
D) 24.2%.

nayizhenfeng

The correct answer is A

ARAROC = (RAROC – RF) / Beta

ARAROC = (22 – 5) / 1.1 = 15.45%.

nayizhenfeng

2、Assume RAROC is 10%, the risk free rate is 4%, the market return is 10%, the firm’s required return on equity is 12%, and the firm’s beta is 1.1. What is the ARAROC and should the project be accepted?

A) 5.5%; reject.
 
B) 5.5%; accept.
 
C) 10%; accept.
 
D) 7.3%; accept.

nayizhenfeng

The correct answer is A

ARAROC = (RAROC ? Rf) / beta = (10% ? 4%) / 1.1 = 5.4545%; Accept when ARAROC > (Rm ? Rf); Rm ? Rf = (Rs ? Rf) / beta (from the SML equation) = (12% ? 4%) / 1.1 = 7.2727%; Reject since 5.5% < 7.3%.