An employee at Azai Bank seeks to evaluate a transaction using the risk-adjusted return on capital (RAROC) model. The transaction entails extending a loan to an agro-based entity with the following details:- The risk-free rate of return is 7%- Loss given default (LGD) = 51%- Exposure at default (EAD) = ZMW 2.5 million- Probability of default (PD) = 40 basis points The bank's economic capital (EC) model assesses an EC charge for the firm, equivalent to 5% of EAD, amounting to ZMW 100,000. Assuming a RAROC hurdle rate of 15%, the transaction yields a net profit of ZMW 14,000 before other adjustments. Tasks:A. Calculate the bank’s risk-adjusted rate of return on the loan to the agricultural company. B. Additionally, consider the scenario where the bank could have extended a loan of the same amount, generating an identical net profit of ZMW 14,000 before adjustments to a pharmaceutical products manufacturing firm, with an EC of 2.5%. C. Determine which loan the bank should prioritize between the two and provide justification.
An employee at Azai Bank seeks to evaluate a transaction using the risk-adjusted return on capital (RAROC) model. The transaction entails extending a loan to an agro-based entity with the following details:
- The risk-free
- Loss given default (LGD) = 51%
- Exposure at default (EAD) = ZMW 2.5 million
- Probability of default (PD) = 40 basis points
The bank's economic capital (EC) model assesses an EC charge for the firm, equivalent to 5% of EAD, amounting to ZMW 100,000. Assuming a RAROC hurdle rate of 15%, the transaction yields a net profit of ZMW 14,000 before other adjustments.
Tasks:
A. Calculate the bank’s risk-adjusted rate of return on the loan to the agricultural company.
B. Additionally, consider the scenario where the bank could have extended a loan of the same amount, generating an identical net profit of ZMW 14,000 before adjustments to a pharmaceutical products manufacturing firm, with an EC of 2.5%.
C. Determine which loan the bank should prioritize between the two and provide justification.
Step by step
Solved in 2 steps
