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Answer: Advantages of RAROC include (i) it has one universal regulatory definition (without credible variants), such that benchmarking against peers is easy; and (ii) it is easy to implement in practice.
## Explanation Option C is the inaccurate statement because: - **RAROC does NOT have one universal regulatory definition** - there are multiple variants and approaches used by different institutions - **Benchmarking against peers is NOT easy** due to different calculation methodologies across firms - **Implementation is NOT necessarily easy** - RAROC requires sophisticated risk measurement systems and data infrastructure Option A is correct - RAROC should exceed the cost of equity capital to create shareholder value. Option B is correct - these are common applications of RAROC in risk management. Option D is correct - the typical RAROC formula is: RAROC = (Risk-adjusted return - Expected losses) / Economic capital, and it's typically calculated on an after-tax basis.
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One of the risk management building blocks is the need to balance risk and reward. Specifically, GARP says, "Economic capital provides the firm with a conceptually satisfying way to balance risk and reward. For each activity, firms can compare the revenue and profit they are making from an activity to the amount of economic capital required to support that activity." Each of the following statements is true about RAROC EXCEPT which is inaccurate?
A
For an activity to increase shareholder value, its RAROC should be higher than the cost of equity capital.
B
Four applications of RAROC include business comparison, investment analysis, pricing strategies, and risk management cost/benefit analysis.
C
Advantages of RAROC include (i) it has one universal regulatory definition (without credible variants), such that benchmarking against peers is easy; and (ii) it is easy to implement in practice.
D
If RAROC's denominator is economic capital, which is typical, then its numerator should be an after-tax risk-adjusted expected return where the risk-adjusted refers to an adjustment for expected losses.
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