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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 **Why Option C is inaccurate:** - **Statement (i) is false**: RAROC does **not** have one universal regulatory definition. Different institutions and regulators may define RAROC differently, making benchmarking against peers challenging rather than easy. - **Statement (ii) is misleading**: While RAROC is conceptually straightforward, implementing it in practice can be complex and challenging due to: - Estimating economic capital accurately - Calculating risk-adjusted returns - Data requirements and modeling complexities - Integration with existing systems **Why the other options are correct:** - **Option A**: Correct - For shareholder value creation, RAROC should exceed the cost of equity capital. - **Option B**: Correct - These are indeed common applications of RAROC in risk management. - **Option D**: Correct - When economic capital is the denominator, the numerator should be after-tax risk-adjusted expected return, where risk adjustment typically accounts for expected losses. The question asks for the EXCEPT statement, meaning we're looking for the one that is NOT true, which is Option C.
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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.