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Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition by Youssef F. Bissada, Jean Dermine

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Solution to Stage Four

1: The allocated profit after tax of the corporate banking division is $4 million. An equity of $20 million has been allocated to this profit centre.

Compute the RAROC, the cost of equity and the EP, knowing that the risk-free rate on government bonds is 10% and that the market demands a risk premium of 5% on bank shares.

Solutions are:

Golden rule for value creation

Value is created by the corporate banking unit whenever the RAROC of 20% exceeds the cost of equity of 15%, or when the EP of $1 million is positive.

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