qingshu

 

3、Of the six methods of allocating economic capital, the one that explicitly incorporates a VAR methodology is the:

A) incremental capital allocation rule. 

B) fair value allocation rule. 

C) RAROC-based proportional scaling rule.

D) stand-alone, market-based allocation rule. 

qingshu

 

The correct answer is B

The fair value method or “fair value allocation rule” measures the net asset value of each business unit “j” (NAVj) using discounted cash flow or some other approach. Then the method requires two values: 1) an estimate of the volatility of the NAVj over the designated horizon and 2) an appropriate confidence level. The economic capital for each unit is essentially the value at risk (VAR) of the NAVj given the two inputs. “RAROC-based proportional scaling rule” is not the best answer because the calculation may be based on VAR or some other bottom-up methodology.

qingshu

 

4、Of the six methods of allocating economic capital, the one that is bottom-up in nature is the:

A) RAROC-based, proportional scaling method.

B) stand-alone, market-based allocation method.

C) incremental capital allocation method.

D) fair value allocation method.

qingshu

 

3、In strategic capital allocation, all of the following steps are part of a bottom-up approach EXCEPT to:

A) estimate the distribution of losses for each portfolio.

B) limit concentration.

C) control the economic capital consumption by each business unit in the period.

D) select the projects based on the hurdle rate.

qingshu

 

The correct answer is C

Controlling the economic capital consumption by each business unit in the period is part of a top-down approach.

qingshu

 

AIM 3: Define and compare the six methods of allocating economic capital.

1、Which of the following methods of allocating economic capital uses a bottom-up approach?

A) Internal betas method.

B) Marginal capital method.

C) Arbitrage pricing theory (APT) method.

D) Scaling method.

qingshu

 

The correct answer is D

The scaling method of capital allocation is a bottom-up approach. This method calculates economic capital for a homogeneous portfolio that corresponds to an appropriate business unit.

qingshu

 

2、Which of the following models of capital allocation estimates the economic capital for a bank and then estimates the economic capital that would be needed without a particular business unit?

A) RAROC-based proportional scaling rule.

B) Incremental capital allocation rule.

C) Fair value allocation rule.

D) Stand-alone method.

qingshu

 

 

AIM 2: Discuss the top-down and bottom-up approaches to capital allocation, including the difference between product and business risk.

1、Which of the following would NOT be a step in the top-down approach to capital allocation?

A) Estimate the distributions of losses for an individual portfolio.

B) Set the capital limits for a business unit.

C) Control the economic capital consumption by each business unit in a period.

D) Assess the risk and return for a business unit.

qingshu

 

The correct answer is A

The top-down approach assesses the risk and return of each business unit and allocates the total capital of the bank accordingly. The steps in the top-down approach to capital allocation include setting capital limits for the business units, controlling the economic capital consumption by each business unit in the period, and reassessing these limits for the next period.