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Week 9 CRM | IT

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Question 1: [5 marks]

Using the Basel II Internal Ratings Based (IRB) the formula for corporate exposures, describe each of the key input variables and their impact on regulatory capital and risk-weighted assets (RWA).

Question 2: [5 marks]

Beyond the regulatory requirement to maintain adequate capital reserves, what other goals does Basel II/III strive to achieve? Discuss in terms of impact on regulatory capital calculations (credit risk only) and an ADI’s risk management culture.

Question 3: [10 marks]

Consider a $300m portfolio comprising 50 unsecured corporate loans. Assuming individual exposures default with probability 3% and LGD=25% and EAD=100%

 a) Derive the mean and standard deviation of portfolio loss assuming loans default independently.

b) Construct the portfolio loss distribution [Hint: use a normal distribution]

c) Derive portfolio VaR and economic capital at the 99th percentile level

 Question 4:[15 marks]

 Repeat 3 assuming a uniform joint default probability of 0.2%. What is the impact on portfolio risk as a result of correlation?

 Question 5:[5 marks]

 Define the key differences between regulatory and economic capital modeling methodologies.

 Question 6:[10 marks]

 Economic capital and AIRB Basel II regulatory capital are both measures of a bank’s credit loss probability density function. Explain the key differences between these approaches and suggest why a bank would invest the effort in measuring Economic Capital when it must calculate RWA using Basel II.

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