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FRM Level 2 Formulas – Operational Risk and Resiliency

Estimated reading time: 1 minute

 

Introduction

We present the formulas for the Operational Risk and Resiliency segment.

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Risk-Adjusted Return on Capital (RAROC)

RAROC = ( Risk Adjusted Return ) / ( Risk Adjusted Capital )

RAROC = [ Revenues – Costing – Taxation – Expected Losses + Return on Capital +/- Transfers ] / Risk Adjusted Capital

Adjusted RAROC = RAROC – β ( Market Return – Risk Free Rate )          

 

Probability of Default

Default Probability = 1 – e lt

We note:

l  =  (Spread) / 1 – Recovery Rate

 

Worst Case Default Rate (WCDR)

WCDR  =  N *  [  N-1 * ( PD )  +  r½ * N-1   ( 0.999 )  /   ( 1 – r )½  ]        

 

Default Correction

rab   =  [ pab  –  (  pa  *  pb )  ] / [ pa * ( 1 –  pa ) ] ½  *  [ pb * ( 1 –  pb ) ] ½                                            

 

Liquidity Cost 

Liquidity Cost = ( Notional Amount X Spread Value ) / 2

 

Summary

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