(a) Michael Bank has a corporate borrower with $900million term loans. The exposure is guaranteed by a Corporate Guarantee with AAA rating up to $500million. Assume the risk weight for the corporate borrower is 50%; risk weight applicable to guarantor is 20%. Assume Substitution Approach is applicable. Determine the capital required if the bank has to maintain a CAR of 11%. (13 marks)

(b) Bank of City One has credit asset of $120 million with a spread of 85 basis points over HIBOR. (HIBOR is currently 1.77% p.a.) Suppose Bank of City One has to pay 70 basis point of its credit asset value to CDS seller and the new risk weighting becomes 20%. Determine the ROE with the use of the CDS.

Additional information: The Bank aims to maintain 10.5% CAR and funding cost is HIBOR. Assume no reserve requirement. (17 marks)