What would be the RAROC for this transaction?

Bank Sigma has an opportunity to do a securitization deal for a credit card company, but has to retain a portion of the residual risk of the deal with an estimated VaR of $8 MM. Its fees for the deal are $2 MM, and the short-term financing costs are $600,000.

What would be the RAROC for this transaction?
A . 25%
B . 17.5%
C . 33%
D . 12%

View Answer

Answer: B

Explanation:

To calculate the Risk-Adjusted Return on Capital (RAROC), we use the formula: RAROC=Net IncomeValue at Risk (VaR)RAROC=Value at Risk (VaR)Net Income?

Here, the net income from the transaction is the fees minus the financing costs: Net Income=$2,000,000-$600,000=$1,400,000Net Income=$2,000,000-$600,000=$1,400,000

The VaR is given as $8,000,000. So, the RAROC is: RAROC=$1,400,000$8,000,000=0.175 or 17.5%RAROC=$8,000,000$1,400,000? =0.175 or 17.5%