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2. (RAROC) Financial institution B wants to evaluate the credit risk of a potential loan to a BBB-rated borrower via the RAROC approach. The contractual loan amount is $2 million, the loan spread (loan interest rate minus cost of funding) is 1.4%, the loan fee rate is 0.15%, and operating cost $800. The current market value and the duration of the loan are calculated to be $1 million and 3.5 years, respectively. The current average yield on BBB-rated bonds is 8%, and the change of the yield over the next year is estimated to follow a normal distribution with mean 1% and variance (0.5%). (a) What is the expected loss EL based on duration? (Hint: use the first equation for loss above (8) in Lecture Notes 03.) (b) What is the RAROC of this loan with confidence level a = 99? 2. (RAROC) Financial institution B wants to evaluate the credit risk of a potential loan to a BBB-rated borrower via the RAROC approach. The contractual loan amount is $2 million, the loan spread (loan interest rate minus cost of funding) is 1.4%, the loan fee rate is 0.15%, and operating cost $800. The current market value and the duration of the loan are calculated to be $1 million and 3.5 years, respectively. The current average yield on BBB-rated bonds is 8%, and the change of the yield over the next year is estimated to follow a normal distribution with mean 1% and variance (0.5%). (a) What is the expected loss EL based on duration? (Hint: use the first equation for loss above (8) in Lecture Notes 03.) (b) What is the RAROC of this loan with confidence level a = 99

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