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Answer: Expected annual revenue increases by 20%.
## Explanation RAROC is calculated as: **RAROC = (Revenue - Expected Loss - Operating Expenses - Funding Cost + Return on Economic Capital) / Economic Capital** Given current RAROC = 21.1% Let's calculate the impact of each option: **Current values:** - Revenue: HKD 16M - Expected Loss: HKD 1M - Operating Expenses: HKD 2M - Funding Cost: 1.0% × HKD 400M = HKD 4M - Return on EC: 2% × HKD 47M = HKD 0.94M **Option A: Operating expenses decrease by 50%** - New Operating Expenses: HKD 1M - Change in numerator: +HKD 1M - RAROC increase: 1/47 = 2.13% **Option B: Revenue increases by 20%** - New Revenue: HKD 19.2M - Change in numerator: +HKD 3.2M - RAROC increase: 3.2/47 = 6.81% **Option C: Return on EC increases to 4%** - New Return on EC: 4% × HKD 47M = HKD 1.88M - Change in numerator: +HKD 0.94M - RAROC increase: 0.94/47 = 2.0% **Option D: Funding cost decreases to 0.5%** - New Funding Cost: 0.5% × HKD 400M = HKD 2M - Change in numerator: +HKD 2M - RAROC increase: 2/47 = 4.26% **Comparison:** - Option A: +2.13% - Option B: +6.81% - Option C: +2.0% - Option D: +4.26% **Option B provides the largest RAROC increase at 6.81%.** The revenue increase has the most significant impact on the numerator while the denominator (economic capital) remains unchanged.
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A risk manager is considering a HKD 400 million loan that will be fully funded by deposits paying an average annual interest rate of 1.0%. The risk manager has estimated the following regarding the loan:
| Expected annual revenue: | HKD 16 million |
|---|---|
| Expected loss: | HKD 1.0 million |
| Unexpected loss: | HKD 48.0 million |
| Economic capital required: | HKD 47.0 million |
| Annual operating expenses: | HKD 2.0 million |
Assuming the economic capital can be invested so that it earns 2% per year, the risk manager correctly calculates the risk-adjusted return on capital (RAROC) to be 21.1%. Assuming nothing else changes, which of the following would increase the RAROC estimate the most?
A
Annual operating expenses decrease by 50%.
B
Expected annual revenue increases by 20%.
C
The economic capital can be invested so that it earns 4% per year.
D
The loan is fully funded by deposits paying an average annual interest rate of 0.5%.
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