Chapter 15: Basel I, Basel II and Solvency II
15.19.
Why is there an add-on amount in Basel I for derivatives transactions? “Basel I could be
improved if the add-on amount for a derivatives transaction depended on the value of the
transaction.” How would you argue this viewpoint?
The capital requirement is the current exposure plus an add-on amount multiplied by the
The current exposure is zero in both cases. In the first case any increase in the value of the
15.20.
Estimate the capital required under Basel I for a bank that has the following transactions with
another bank. Assume no netting.
(a) A two-year forward contract on a foreign currency, currently worth $2 million, to buy foreign
currency worth $50 million
(b) A long position in a six-month option on the S&P 500. The principal is $20 million and the
current value is $4 million.
(c) A two-year swap involving oil. The principal is $30 million and the current value of the swap
is –$5 million.
What difference does it make if the netting amendment applies?
Using Table 15.2 the credit equivalent amounts (in millions of dollars) for the three transactions
are
If netting applies, the current exposure after netting is in millions of dollars 2+4−5 =
15.21.
A bank has the following transaction with a AA-rated corporation
(a) A two-year interest rate swap with a principal of $100 million that is worth $3 million
(b) A nine-month foreign exchange forward contract with a principal of $150 million that is
worth –$5 million
(c) An long position in a six-month option on gold with a principal of $50 million that is worth
$7 million
What is the capital requirement under Basel I if there is no netting? What difference does it make
if the netting amendment applies? What is the capital required under Basel II when the
standardized approach is used?
Using Table 12.2 the credit equivalent amount under Basel I (in millions of dollars) for the three
transactions are
If netting applies, the current exposure after netting is in millions of dollars 3 − 5 + 7 = 5. The
The risk weighted amount is 3.375 and the capital required is 0.08 × 3.375 = 0.27. In this case
the netting amendment reduces the capital by 46%.
15.22.
Suppose that the assets of a bank consist of $500 million of loans to BBB-rated corporations.
The PD for the corporations is estimated as 0.3%. The average maturity is three years and the
LGD is 60%. What is the total risk-weighted assets for credit risk under the Basel II advanced
IRB approach? How much Tier 1 and Tier 2 capital is required? How does this compare with the
capital required under the Basel II standardized approach and under Basel I?
Under the Basel II advanced IRB approach
= 0.12[1 + e−50×0.003 ] = 0.2233
