Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

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.