Sigma Bank has the following balance sheet in millions of dollars.Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns).Values are in millions of dollars.Refer to table 20-8 for appropriate risk weights. $$\begin{array} { | l | r | l | r | }
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l }
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l }
\text { Residential Mortgages } \
\text { 1-4 family } \
\left( 80 \% { - 90\% } \text { LTV } \right)
\end{array} & \$ 100 & \begin{array} { l }
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l }
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$10\
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10) $40 million direct-credit substitute standby letters of credit issued to a U.S.corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
What is the minimum total capital (Tier I + Tier II) required to be adequately capitalized for the off-balance sheet derivative contracts (both interest rate swaps and foreign exchange forwards) under Basel II?

Question

Sigma Bank has the following balance sheet in millions of dollars.Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns).Values are in millions of dollars.Refer to table 20-8 for appropriate risk weights. $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { 1-4 family } \
\left( 80 \% { - 90\% } \text { LTV } \right)
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$10\
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10) $40 million direct-credit substitute standby letters of credit issued to a U.S.corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
What is the minimum total capital (Tier I + Tier II) required to be adequately capitalized for the off-balance sheet derivative contracts (both interest rate swaps and foreign exchange forwards) under Basel II?

Quizplus · Accepted Answer

The minimum total capital required is calculated using the credit equivalent amount of the derivatives. For interest rate swaps, the credit conversion factor is 0.5% for the notional amount, and for forward contracts, it is 1.0%. Therefore, the capital required is (0.5% of $200 million) + (1.0% of $100 million) = $1 million. The risk weight for these derivatives is typically 8%, so the capital requirement is 8% of $1 million = $0.08 million. However, the question asks for the total capital required, which includes both Tier I and Tier II capital, so the correct answer is $0.72 million.

Sigma Bank Has the Following Balance Sheet in Millions of Dollars.Unless