Bustic

Question 1

EPD Ratio

Answer 1

EPD Ratio = EPD / E[Loss]

Question 2

EPD

Answer 2

EPD = Summation( pr(Lossi) x (Lossi - Asset)

Question 3

Capital to Expected Loss Ratio

Answer 3

A = C + L

C / L = C / E[Loss]

calculated at t=0 unless asked otherwise

Question 4

Joint distribution tips

Answer 4

Pay attention if 1 line has the possibility of no losses.

Ensure distribution adds up to 1.

Question 5

EPD Standard normal distribution (fixed assets)

Answer 5

EPD Ratio = k x PDF(-c / k) - c x CDF(-c / k) where

c = C / L

k = std dev loss / L

Question 6

EPD Standard normal distribution (fixed losses)

Answer 6

EPD Ratio = 1 / (1 - ca) x [ka x PDF(-ca / ka) - ca x CDF(-ca / ka)] where

ca = C / A

ka = std dev assets / Assets

Question 7

RBC Square Root Steps

Answer 7

RBC captial = capital ratio x amount

Modify correlations to reflect if elements are on the same or opposite side of the balance sheet (flip correlation signs if opposite)

C= SqRt ( Summation(C^2) + Sum(Sum(pijCiCj)) for all combination given
don’t forget to double the second component because you go through the same elements twice

Cfull corr = Summation C

Cindependent = SqRt (Summation(C^2))

Question 8

EPD to allocate capital Advantages/Disadvantages

Answer 8

Advantages

• Contemplates severity of loss > assets
• Consistent with financial theory
• Each line can be set to the same EPD

Disadvantages

• Does not reflect diversification benefit
• May not have enough capital
• arbitrary threshold

Question 9

RBC Comments

Answer 9

The range between full correlation and independent demonstrate the importance of correlation between elements in terms of the required capital. There can be significant diversification benefits.