Assume a $500 000 loan has a duration of 2.5 years. The current interest rate level is 10 per cent and a sudden change in the credit premium of 1 per cent is expected. Further assume that the one-year income on the loan is $2500. What is the loan's RAROC (round to two decimals)?

Question

Quizplus · Accepted Answer

First, let's calculate the loan's annual interest rate (AIR):

AIR = (1 + interest rate) x (1 + credit premium)^(1/duration) - 1
AIR = (1 + 0.10) x (1 + 0.01)^(1/2.5) - 1
AIR = 0.1189 or 11.89%

Next, let's calculate the loan's annual income:

Annual income = one-year income / duration x 100
Annual income = $2500 / 2.5 x 100
Annual income = $10000 or 10%

Finally, let's calculate the loan's risk-adjusted return on capital (RAROC):

RAROC = annual income / (loan amount x AIR)
RAROC = $10000 / ($500000 x 0.1189)
RAROC = 0.1684 or 16.84%

Therefore, the loan's RAROC is 16.84%, which is closest to option C (22%).

Assume a $500 000 Loan Has a Duration of 2