Explanation:
RAROC =
| Expected Profit | Economic capital | Calculation | |
|---|---|---|---|
| Tarragona Construcciones | 3,000,000 | 50,000,000 | |
| Valencia Bonos | 1,500,000 | 22,000,000 |
The RAROC for Valencia Bonos (0.068) is greater than the cost of equity (0.062), thus it is most likely the next investment opportunity for the bank.
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Q.2207 A Catalan bank is looking to expand its business lines. The management decides that the primary condition for investment will be the highest RAROC (risk-adjusted return on capital). The possibilities being discussed are:
I. Tarragona Construcciones, with an expected net profit of EUR 3,000,000 per year and economic capital of EUR 50,000,000; and
II. Valencia Bonos, with an expected net profit of EUR 1,500,000 per year and economic capital of EUR 22,000,000.
Assuming the cost of equity is 0.062, based on RAROC, the bank would most likely invest in:
A
Tarragona Construcciones
B
Valencia Bonos
C
Both projects
D
None – neither of the two would be economically viable