Abstract

Introduction
Ken Froot - Harvard University and NBER

I. Definition of Risk and Capital in Modern Financial Institutions

A. Defining Capital in Financial Firms

B. Profitability, Risk, and Capital

1. Earnings risk

2. Earnings drift

C. Asset Values and Firm Collateral on Call

1. The value of balance sheet assets

2. Collateral on call

II. The Internal Pricing of Risks

A. Pricing Capital in Warehousing Activities

1. Capital allocation is not capital pricing

2. Internal prices must compensate capital providers for systematic risk

3. Internal prices must compensate capital providers for corporate financing

4. Internal prices must compensate capital providers for intra-corporate

B. Pricing Capital With Other, Non-Warehousing Activities

III. Conclusion