The duration of a soon to be approved loan of $10 million is four years.The 99^th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the estimated risk-adjusted return on capital (RAROC) of this loan.

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Quizplus · Accepted Answer

Firstly, let's calculate the risk premium of the loan: Risk premium = 5.5% x 99^th percentile = 5.5% x 1.282 = 7.05% Next, let's calculate the expected return: Expected return = risk-free rate + risk premium Assuming the risk-free rate is 2.5%, we get: Expected return = 2.5% + 7.05% = 9.55% Finally, let's calculate the RAROC: RAROC = (expected return - cost of funding) / amount of capital Assuming the cost of funding is 4%, we get: RAROC = (9.55% - 4%) / $10 million = 0.555% or 5.55% Therefore, the estimated RAROC of the loan is 7.13% (9.55% - 2.42%).

The Duration of a Soon to Be Approved Loan of $10