1.A)

As a summer intern at Missouri State Bank, you are asked to verify their analysis of risk capital, in both historical contexts and the current regulatory environment. The bank has the following items on its balance sheet: $1,200 million of corporate loans (out of which, $500 million are rated AA, $400 million rated A, $200 million rated BBB, and $100 million rated B), $750 million of bonds issued by Bank of America with a credit rating of AA, $350 million of U.S. Treasury notes, $420 million of Treasury bonds issued by Argentina (with a rating of B), $900 million of uninsured residential mortgages, and $650 million of personal loans. Additionally, the bank has the following transactions with a BB-rated corporation: (a) a 5-year interest rate swap with a principal of $325 million worth -$40 million; (b) a 3-year foreign exchange forward contract with a principal of $380 million worth $30 million; c) a 9-month option on Russel 2000 index with a principal of $285 million worth $20 million (here the principal amount is roughly the exercise price amount), d) a 3-year forward contract on gold with a principal of $485 million and is currently worth $29 million, and e) a 1-year forward contract on crude oil with a principal of $760 million and is currently worth -$24 million. What is the total capital requirement under Basel I if there is no netting? What difference does it make if the netting amendment applies? What is the total capital required under Basel II when the standard approach is used?(Note: when calculating numbers in millions of dollars, keep four decimal places.)

B)

You are also asked to assess the capital for a particular trading desk at the bank which has positions in various derivatives and other securities. Its up-to-date10-day, 99% VaR and stressed VaR are $35 million and $60.5 million respectively. The corresponding averages over the previous 60 days are $11.5 million and $16.25 million. The multipliers m_c and m_s are 3.35 and 3.65. Please calculate the total capital charge under Basel II and Basel II.5. Explain the overall impact of Basel II.5 on capital requirement relative to that under Basel II. Why is each of the capital charge component calculated as the maximum of two items? What is the logic behind it?