FOR TRANSFER PRICING

Transcription

1 KAMAKURA RISK MANAGER FOR TRANSFER PRICING KRM VERSION 7.0 SEPTEMBER Telephone: Facsimile: Kalakaua Avenue, 14th Floor, Honolulu, Hawaii 96815, United States of America

2 Contents I. Advanced Profitability Management through Transfer Pricing II. Precise Modeling of Transfer-Priced Instruments III. Flexible Calculation and Assignment of Transfer Rates IV. Advanced Interest Rate Modeling V. Sophisticated Interest Rate Option Valuation Techniques VI. Dynamic Multi-Period Profitability Measurement VII. Advanced Credit-Adjusted Profitability Analysis VIII. Adaptable Aggregation of Profitability Analysis Results IX. Interactive Presentation of Profitability Analysis Results X. Open, Extendible Data Architecture XI. Automated Process Management XII. Integrated Performance and Risk Analysis Solution 2

3 I. Advanced Profitability Management through Transfer Pricing Transfer pricing is an internal profitability measurement approach through which a marketbased risk management process for an entire organization can be translated into practical tools for motivation and management of organizational units with a financial accounting perspective. It allows funding and interest rate risk management of individual transfer transactions to be performed by funding and risk centers with market and risk management expertise while individual line business units determine the pricing, volumes, and residual risk of those transactions. This profitability management approach has been adopted by many organizations with financial instrument portfolios to enhance their understanding of portfolio profitability dynamics and improve profitability and shareholder value through informed decision making. Kamakura Corporation founder Dr. Donald R. van Deventer worked under Bank of America s Wm. Mack Terry, the originator of the transfer pricing concept, during the implementation of the Bank of America transfer pricing system in For a history of transfer pricing and an example of its application, see Chapter 2 of Advanced Financial Risk Management (John Wiley & Sons, 2004) by Kamakura s van Deventer, Imai and Mesler. Transfer pricing measures the profitability of financial instruments in an organization s portfolio by attributing a net business margin to funds invested or acquired. The net business margin represents the difference between the contractual rate for a financial instrument and the transfer pricing rate for the instrument. The contractual rate is the coupon rate for an instrument specified by its contractual terms, while the transfer pricing rate is the rate paid by a business line unit or functional unit to transfer funds and risk to funding and risk centers. The net business margin can also include potential credit losses on an instrument as well as fees or expenses associated with an instrument. When the net business margin is applied to the balance of an instrument, it provides the basis for projecting the profitability of the instrument to an organizational or functional unit over one or more future time periods. This provides insight into the dynamics of margins and a basis for increasing shareholder value. Transfer pricing can also measure the profitability of financial instruments to funding and risk centers by attributing a net funding margin or mismatch margin to funds invested or acquired. The net funding margin is the difference between the transfer pricing rate for a financial instrument and the funding rate for the instrument. The funding rate is the rate paid by a funding and risk center to transfer funds and risk to external entities. When the net funding margin is applied to the balance of an instrument, it provides the basis for projecting the profitability of the instrument to a funding and risk center over one or more future time periods. 3

4 Kamakura s enterprise risk management solution, the Kamakura Risk Manager (KRM), provides advanced, comprehensive functionality to facilitate profitability measurement through its KRM Transfer Pricing (TP) component. KRM TP offers advanced features for transfer pricing including: Precise Modeling of Transfer-Priced Instruments Flexible Calculation and Assignment of Transfer Rates Advanced Interest Rate Modeling Sophisticated Interest Rate Option Valuation Techniques Dynamic Multi-Period Profitability Measurement Advanced Credit-Adjusted Profitability Analysis Adaptable Aggregation of Profitability Analysis Results Interactive Presentation of Profitability Analysis Results Open, Extendible Data Architecture Automated Process Management Integrated Performance and Risk Analysis Solution These powerful features provide a superior transfer pricing solution for organizations interested in improving their profitability management processes. II. Precise Modeling of Transfer-Priced Instruments KRM TP extends the precise modeling of financial instruments offered by the KRM solution. The financial instrument models available in KRM describe all of the contractual attributes of each instrument required to determine the exact timing and amounts of the instrument s future cash flows, income, and expenses in the contractual currency denomination(s) of the instrument. These attributes include coupon payment terms, such as coupon rate, payment frequency, and payment lag, principal amortization terms, such as constant payment, bullet, or customized, payment day calendars, and floating-rate coupon terms, such as reset frequency, reset lag, and rate index. The financial instrument models also incorporate attributes related to embedded options, such as interest rate caps and floors and call and put options on remaining instrument cash flows, and attributes associated with default and recovery processes for the instrument. The precise financial instrument models available in KRM TP provide the basis for accurate calculation of transfer pricing rates and simulation of transfer pricing income at the level of individual transactions in an organization s portfolio. These models are essential for transactions with embedded optionality and for defaultable transactions where the transfer rate should reflect the transaction s option- and credit-adjusted value. These models also allow the unique characteristics of individual transactions to be incorporated in the transfer pricing valuation and income analysis rather than obscuring these characteristics by modeling transaction aggregates. 4

5 III. Flexible Calculation and Assignment of Transfer Rates KRM TP offers alternative methods for calculating transfer rates and permits selection of the transfer rate method deemed most appropriate for each category of transfer-priced instruments. Each transfer-priced instrument is associated with a specific transfer pricing rate method in KRM TP. A transfer pricing rate method specifies a transfer pricing rate model, a transfer pricing yield curve, a transfer pricing date, and transfer pricing lag and adjustment parameters. Different transfer pricing rate methods can be defined by specifying these transfer pricing rate method components. The availability of multiple transfer pricing rate methods provides compatibility with existing transfer pricing methodologies and facilitates use by profit center managers with different profitability management objectives. KRM TP offers a range of transfer pricing rate methods ranging from a simple LOCKED- IN SPREAD method to methods like the CASH FLOW PV MATCHED method that build on detailed financial instrument characteristics and on yield curve models. This allows an organization to use a method that provides acceptable accuracy and ease of use, and it permits an organization to use different transfer pricing rate methods for different portions of its portfolio, as appropriate. KRM TP provides nine models for calculating transfer pricing rates for transfer-priced instruments. These transfer pricing rate models include using external models that produce user-defined transfer pricing rates for an instrument as well as several models that calculate transfer pricing rates based on attributes of the transfer-priced instrument, derived performance and risk measures for the instrument, prepayment and credit characteristics of the instrument, and a transfer yield curve. The transfer pricing rate models available in KRM TP are shown in the accompanying table. 5

6 KRM Transfer Pricing Rate Models Model User Defined Cash Flow PV Matched Principal Weighted Average Original Maturity or Reset Period Duration Weighted Average Life Rate Index Function Locked-In Spread Internal Rate Of Return Description Rate is provided by user based upon an external model or other source Rate required to equate expected discounted future cash flows to the initial balance using discount rates from the transfer pricing yield curve at cash flow tenors Rate equal to the weighted average of the yields from the transfer pricing yield curve at the principal cash flow tenors weighted by the product of the principal cash flow tenor and amount Rate obtained from yield on the transfer pricing yield curve at a tenor corresponding to the original maturity (for fixed-rate instruments) or current coupon rate reset period (for floating-rate instruments) Rate obtained from the yield on the transfer pricing yield curve at a tenor corresponding to the expected duration of the future cash flows of the instrument Rate obtained from the yield on the transfer pricing yield curve at a tenor corresponding to the expected weighted average life of the future cash flows of the instrument Rate calculated using a floating-rate index function defined by an arithmetic expression of rates at different tenors on the transfer yield curve and other variables Rate equal to the current coupon rate of the instrument minus (plus) an instrument-specific rate spread for the asset (liability) Rate equal to the internal rate of return (IRR) of the future cash flows of the instrument as of its issue date The transfer pricing rate produced by KRM TP for each instrument can be calculated based on the time the instrument is acquired to assure that the rate reflects current market conditions at that time. When the instrument is originated or issued by the holder, the transfer pricing rate calculation is based upon an origination or issuance date and the original maturity tenor for the instrument. When the instrument is acquired by the holder through a secondary market trade, the transfer pricing rate calculation is based upon the trade date and the remaining tenor at the trade date for the instrument. Finally, when a currently-held instrument has not been previously transfer priced, the transfer pricing rate calculation can be based upon the current date and the remaining tenor at the current date. KRM TP assigns transfer pricing rates to transfer-priced instruments in a portfolio by applying the transfer pricing rate method selected for each instrument. Depending upon the transfer pricing rate method, the transfer pricing process performs the valuation, averaging, duration, and other calculations required for that method. The transfer pricing rate produced by the transfer pricing process for each instrument is assigned as an attribute of the instrument and is retained in the KRM database. 6

7 Transfer Pricing Rates in KRM Financial Instrument Model Timing and Amounts of Known and Contingent Cash Flows of Financial Instrument Transfer Pricing Method Transfer Pricing Rate Calculation Method Predefined Instrument Dependent Yield Curve Dependent Yield Volatility Dependent Credit Model Dependent Transfer Pricing Model Modeling Approach for Transfer Pricing Rate User Defined Cash Flow PV Matched Principal Weighted Average Original Maturity or Reset Period Duration Weighted Average Life Rate Index Function Locked-In Spread Internal Rate of Return Transfer Pricing Rate Exposure Value Recovery Model Dynamic Recovery Process Timing and Amounts for Credit Exposure Instrument Exposure Recovery Process Behavior Obligor Default Model Dynamic Default Intensity for Obligor Counterparty Obligor Default Behavior Yield Curve Model Discount Rates on Transfer Pricing Yield Curve on Financial Instrument Acquisition Date Tenor Based Cash Flow Valuation Interest Rate Volatility Model Interest Rate Volatilities on Transfer Pricing Curve on Financial Instrument Acquisition Date Embedded Interest Rate Optionality KRM provides instrument-specific methods for assigning transfer pricing rates to financial instruments that can be based on yield curves, interest rate volatilities, and credit risk models Assigning Transfer Pricing Rates Financial Instrument Model Timing and Amounts of Known and ContingentCash Flows of Financial Instrument Transfer Pricing Method Transfer Pricing Rate Calculation Method Predefined Instrument Dependent Yield Curve Dependent Yield Volatility Dependent Credit Model Dependent Transfer Pricing Model Modeling Approach for Transfer Pricing Rate User Defined Cash Flow PV Matched Principal Weighted Average Original Maturity or Reset Period Duration Weighted Average Life Rate Index Function Locked-In Spread Internal Rate of Return Transfer Pricing Yield Curve Model Discount Rates at Cash Flow Tenors on Transfer Pricing Yield Curve on Financial Instrument Acquisition Date Profitability Analysis Obligor Default Model Dynamic Default Intensity for Obligor Counterparty Exposure Value Recovery Model Dynamic Recovery Process Timing and Amounts for Credit Exposure Instrument Transfer Pricing Interest Volatility Model Interest Rate Volatilities on Transfer Pricing Yield Curve on Financial Instrument Acquisition Date 7

8 IV. Advanced Interest Rate Modeling KRM TP incorporates the advanced interest rate modeling functionality available in the KRM solution. This functionality supports definition of one or more transfer pricing yield curves for each currency denomination of transfer-priced instruments. This allows transfer pricing rates for different categories of transfer-priced instruments to be calculated using a transfer pricing rate method and a transfer pricing yield curve appropriate to each instrument category. The interest rate modeling functionality also supports definition of valuation and funding yield curves for each currency denomination of transfer-priced instruments. KRM TP uses the valuation yield curves to determine the economic value of transfer-priced instruments at different points in time, and it uses the funding yield curves to determine the funding cost of the transfer-priced instruments at those times. Many of the transfer pricing rate models available in KRM TP depend upon yields or discount rates at one or more tenors on a transfer pricing yield curve for the transfer pricing date, and these tenors usually do not coincide with the tenors of observed yields in the market on that date. This dependency is supported in KRM TP by smoothing the transferring price yield curve in a manner chosen by the user so that there is a transfer pricing rate for any maturity on each transfer pricing date. The yield curve smoothing functions in KRM define the relationship between a specified tenor and the yield, discount rate, or forward rate corresponding to that tenor on the transfer pricing date. KRM TP provides several different forms of yield curve smoothing methods that can be employed in transfer pricing. There are six methods in KRM for smoothing the yield curve itself, and an additional six methods for smoothing the credit spread relative to a risk free yield curve. For more on these smoothing techniques, please see Chapters 8 and 18 of Advanced Financial Risk Management. KTM TP can also calibrate the parameters of the yield curve for a transfer pricing date to observed market yields or bond prices with similar risk characteristics on that date. These features assure that the calculated transfer rate is an accurate indicator of the market interest rates applicable to each financial instrument on the transfer pricing date for that instrument. Transfer-priced instruments often contain embedded options, such as a call option on the remaining cash flows of the instrument or a prepayment option. Additionally, transferpriced floating-rate instruments have future cash flows that are contingent upon future interest rates, and these instruments may also have embedded rate options, such as caps or floors. The value of these embedded interest rate options depends upon the dynamics of the underlying interest rates and the yield curve from which they are obtained. KRM TP models these interest rate dynamics for a given yield curve using one of several forms of parameterized dynamic yield curve (term structure) models, such as the Hull White (extended Vasicek) model. KRM TP can also calibrate the parameters of the dynamic yield curve models using a sample of historical yield curves or a set of implied swaption volatilities. These features provide the underlying interest rate models required for valuation of complex interest rate options. 8

9 V. Sophisticated Interest Rate Option Valuation Techniques Accurate transfer pricing of financial instruments with embedded options requires valuation of those instruments when models such as the CASH FLOW PV MATCHED model are used to determine transfer rates. Accurate valuations of the embedded options are obtained through use of sophisticated interest rate option valuation techniques. These techniques determine the arbitrage-free value of embedded interest rate options based on an underlying dynamic yield curve model, the contractual terms of the embedded options, and behavioral models for prepayments, early withdrawals, and changes in the balances of variable balance instruments. Depending upon the form of the interest rate options, KRM TP can apply different option valuation techniques to determine the value of the embedded options. KRM TP offers several alternative techniques for calculating the value of the embedded interest rate options in transfer-priced instruments. For some types of instruments, an analytical technique such as the Jamshidian option valuation formula can be used to obtain a closed-form valuation. For other instruments, a numerical calculation technique must be employed to determine the value of the embedded interest rate option. KRM TP offers several different numerical techniques for interest rate option valuation, including the trinomial lattice, binary tree, and Monte Carlo numerical techniques, to derive the embedded option value when an analytical technique cannot be used. These numerical techniques generally involve a tradeoff between the precision of the valuation result and the computational effort required for valuation. KRM TP allows selection of the numerical valuation technique applied to each transfer-priced instrument, and it permits the control parameters of each numerical valuation technique to be varied to accommodate this performance vs. precision tradeoff. Mortgage loans, mortgage securities, and other financial instruments with prepayment or early withdrawal rights are an important subset of instruments with embedded options that can be transfer priced in KRM TP. The prepayment behavior of these instruments can be described using any of several different forms of prepayment rate or intensity models. Different prepayment models can be defined for different categories of instruments, and a specific prepayment model can be associated with each prepayable instrument. The prepayment models available in KRM TP can be defined as functions of the characteristics 9

10 of the instruments to which they apply (e.g. age) and as functions of interest rates and macroeconomic or other simulated risk factors. These functional models describe the stochastic behavior of prepayment rates or intensities, and they are incorporated into the valuation of the prepayable instruments to which they apply. VI. Dynamic Multi-Period Profitability Measurement KRP TP extends the powerful multi-period portfolio simulation functionality available in the KRM solution to support profitability measurement based on transfer pricing analysis. The multi-period simulation functionality produces projected interest cash flow, income and expense, accrued interest, and market value results for each transfer-priced instrument during a specified sequence of accounting periods based on simulated yield curves and other factors during those periods. The periods in the accounting calendar are fully customizable to allow results to be calculated with the time granularity required for profitability measurement. The projected results during each accounting period produced by KRM TP include interest income and expense amounts for each transfer-priced instrument calculated using the contractual, transfer, and funding rates applicable to the instrument. Interest cash flows during an accounting period and accrued interest at the end of each accounting period are also calculated using the contractual, transfer, and funding rates. Additionally, KRM TP determines the economic (market) value of each transfer-priced instrument at the end of each accounting period using the valuation, transfer, and funding yield curves, which allows projected unrealized gains and losses in the value of the instrument to be derived for the accounting period. These KRM TP results provide the basis for projecting the net business margin and net funding margin for each transfer-priced instrument for each accounting period under the simulated yield curves for that period. KRM TP calculates the interest cash flow, income and expense, accrued interest, and market value results for each transfer-priced instrument by considering all of the contractual and behavioral characteristics of each instrument. In particular, KRM TP determines these results considering any embedded options in each instrument and whether these options are exercised on their contractual exercise dates. This includes embedded options that are modeled as prepayment rates, where a portion of the outstanding balance of an instrument can be prepaid periodically. KRM TP further enhances profitability measurement through scenario analysis and dynamic portfolio strategies. Scenario analysis is a set of features available in KRM s multi-period portfolio simulation functionality that supports definition of deterministic and stochastic yield curve and risk factor scenarios and application of these scenarios to project the interest cash flow, income and expense, accrued interest, and market value results for each transferpriced instrument over a sequence of accounting periods. Deterministic scenario analysis in KRM TP relies upon a user-defined yield curve and risk 10

11 factor path over the accounting periods to specify the future yield curves and risk factor values required to determine transfer pricing results during future periods. Deterministic scenario analysis can be used to perform stress tests of the projected net business margin and net funding margin results for transfer-priced instruments during the accounting periods. Stochastic scenario analysis projects transfer pricing results over a sequence of accounting periods for each yield curve and risk factor sample path in a randomly generated set of paths produced using a parameterized stochastic process model for yield curve and risk factor evolution. KRM TP applies each randomly generated yield curve and risk factor sample path produced by the stochastic process model to project the transfer pricing results for each transfer-priced instrument during each accounting period. The transfer pricing results across all sample paths provides a sample distribution of the projected interest cash flows, income and expense amounts, accrued interest amounts, and market values of transferpriced instruments during each accounting period. This provides a probabilistic view of net business margins and net funding margins where, e.g. the probability of the net business margin falling below a specified level during an accounting period can be estimated. Another important feature of KRM TP is the ability to specify dynamic portfolio strategies and incorporate those strategies in profitability measurement. Dynamic portfolio strategies are defined using the new business and rollover reinvestment/refinancing functionality available in the KRM solution. The new business functionality in KRM TP allows the user to specify future volumes of specific financial products at future points in time, where these volumes can be specific amounts or can be based on simulated yield curve and risk factor values. The specified product volumes are used by KRM TP to create new financial instruments at the designated times during a multi-period simulation. This functionality allows planned growth in transaction volumes to be incorporated into profitability measurement. The reinvestment/refinancing functionality in KRM TP allows the user to specify the treatment of rollover cash flows resulting from principal and interest, option exercises, and other payments occurring during future time periods in a multi-period simulation. This functionality permits net cash flows from each financial product in a portfolio on a cash flow date or over a specified period to be allocated to reinvestment or refinancing in one or more designated financial products or to be treated as a cash outflow/inflow to the portfolio. The allocations of net cash flows to products can be stated as specific percentages or they can be based on simulated yield curve and risk factor values. This functionality allows assumptions about reinvestment and refinancing to be incorporated into profitability measurement. VII. Advanced Credit-Adjusted Profitability Analysis Traditional profitability analysis for transfer-priced instruments assumes that the contractual obligations of each instrument will be satisfied and the obligor will not default on these 11

12 obligations. However, real world profitability for many types of instruments is significantly affected by the default risk of obligors and the potential credit losses incurred upon default. To address this gap, credit risk models must be incorporated into profitability measurement. KRM TP builds upon the credit risk modeling and analysis functionality available in the KRM solution to close this gap. The credit risk modeling functionality available in KRM includes default probability models for obligors and recovery process models for financial instruments. These models can be used to project potential credit losses and calculate projected credit-adjusted cash flows and income and expense on transfer-priced instruments. Additionally, these models can be incorporated into valuation of transfer-priced instruments to provide credit-adjusted economic (market) values and credit-adjusted transfer rates for these instruments. The default models available in KRM TP describe the probability that an obligor will default on its obligations during a given time period. These models are defined by default intensity functions that can be used to randomly simulate default events for obligors during a multiperiod portfolio simulation. KRM TP can simulate default events at random times, and these default events are propagated to the financial instruments where the defaulting entity is the obligor. When a default event is propagated to an instrument, it becomes a defaulted instrument, and a recovery process is initiated for the instrument. This allows profitability analysis to be extended to defaulted instruments that are held by an organization. KRM TP also provides recovery process models that describe how recoveries occur on defaulted financial instruments. The simplest model assumes that recovery occurs instantaneously in an amount equal to a fraction of the amount due on the defaulted instrument. KRM TP can also model recovery processes that occur randomly as a sequence of recovery events over time where each recovery event produces a recovery amount equal to a random fraction of the amount due on the instrument. This allows profitability analysis to be performed on defaulted instruments where credit losses occur at the time of default and these losses are partly offset by recoveries subsequent to default. When the default and recovery models are incorporated in the multi-period portfolio simulations performed by KRM TP, default and recovery related cash flows and income and expense results for transfer-priced instruments are produced. These results include recovery cash flow amounts at simulated recovery times, credit loss expense amounts at default times, and credit loss recovery income amounts at recovery times. These results can be used to calculate the projected credit-adjusted margins for the transfer-priced instruments. Default and recovery models can also be incorporated in the yield curve models used by KRM TP to provide credit-adjusted yield curves. These credit-adjusted yield curves can be used as transfer pricing yield curves for transfer pricing rate methods. This allows the transfer pricing rate for a transfer-priced instrument to be adjusted for the credit risk of the instrument when a valuation-based transfer pricing rate method is employed. 12

13 VIII. Adaptable Aggregation of Profitability Analysis Results Accurate transfer pricing and profitability measurement require net margin calculations for individual financial instruments, but profitability management is typically based upon the net margins for aggregates of financial instruments related to product categories, individual customers, customer groups, transfer categories, organizational profit centers, etc. These aggregate net margins are obtained by defining category enumerations and hierarchy trees and identifying transfer-priced instruments with individual categories or tree nodes. Each organization has its own approach to profitability measurement and to defining the aggregates to be managed, and the transfer pricing solution should be adaptable in specifying the required aggregates. KRM TP supports these requirements by providing product, transfer pricing, and organizational identifier attributes and categorical attributes in financial instrument models as well as category and hierarchy definitions. This allows the net margin results calculated for individual financial instruments by KRM TP during a multiperiod income simulation to be aggregated and viewed by the KRM Risk Portal or other software. It also allows the aggregated results for products, transfers, or other aggregates to be disaggregated and displayed by the KRM Risk Portal. IX. Interactive Presentation of Profitability Analysis Results The value of profitability analysis is greatest when the results are available to product, transfer pricing, and business unit managers in a timely fashion and in a form most relevant to each manager. The value of profitability analysis results is further enhanced when managers can interactively view disaggregated results to identify products, transfer pricing, or business units where profitability can be improved. The KRM Risk Portal (RP) component of the KRM solution delivers the transfer pricing and profitability measurement results produced by KRM TP to satisfy these objectives. KRM RP is a web application that can be accessed by an authorized user through a standard web browser. KRM RP provides predefined profitability analysis reports that can be selected by the user, and it also allows customized reports to be defined and produced by the user. KRM RP allows the user to interactively choose the category and hierarchy aggregates to be viewed and to drill down to view sub aggregated or financial instrument level profitability results. 13

14 Relationship Profitability Results in USD Dec 2008 January 2009 Relationship Manager Relationship Entity Average Contractual Rate (%/yr) Gross Income Average Transfer Rate (%/yr) Risk Transfer Expense Net Business Margin Average Contractual Rate (%/yr) Gross Income Average Transfer Rate (%/yr) Risk Transfer Expense Net Business Margin Charles French Consolidated Foods , ,057 45, , ,527 42,975 Star Milk Products , ,224 23, , ,975 25,748 Gold Crown Bakeries , ,308 13, , ,318 13,861 Subtotals 317, ,589 82, , ,821 82,584 James Fairchild X. Open, Extendible Data Architecture KRM TP is built upon the open, extendible data architecture of the KRM solution, which provides an open relational data model for all portfolio, market, modeling, processing, and results data retained in the KRM database. This allows KRM TP to be easily integrated with existing data sources in an organization through use of existing data integration tools and standard relational data queries. It also allows KRM TP to provide transfer pricing results to other analytical tools, such as an organization s budgeting system. Users can extend the KRM data model to accommodate additional information related to the profitability analyses performed by KRM TP. For example, accounting results produced by an organization s financial accounting systems can be compared with transfer pricing results previously produced by KRM TP. This allows for reconciliation and back testing to be performed using the KRM TP results. The KRM data model can be implemented using a standard relational database management system, such as Oracle or SQL Server. This allows the powerful functionality available in these systems to be used to extend the functionality available in KRM TP. XI. Automated Process Management KRM TP automates repetitive transfer pricing and profitability analysis processes by encapsulating each process in a processing task description and a sequence of processes in a task schedule. The processing task description identifies the transfer-priced instruments to be analyzed, the set of yield curves to be used for analysis, the option valuation methods to be applied to different financial products, the accounting periods for multi-period simulations, the scenarios and risk factor models applied to simulations, and other details of each task. Processing task descriptions can be retained in the KRM database to enable repetitive 14

15 application of a particular processing task to a portfolio of transfer-priced instruments. A batched sequence of data management, transfer pricing analysis, and reporting tasks can be set up as a task schedule in KRM TP. This allows a set of related processes to be performed without user intervention. KRM TP can produce a processing log indicating the steps performed in each processing task. This log can serve as an audit trail of the tasks that were performed and the results that were produced on a given processing date. XII. Integrated Performance and Risk Analysis Solution KRM TP is a component of an integrated performance and risk analysis solution, the Kamakura Risk Manager. This provides many benefits to organizations with comprehensive risk and performance analysis requirements. These benefits include: A unified performance and risk modeling framework where the same models are used for market risk, credit risk, ALM, transfer pricing, Basel II, capital allocation, and other analyses A common set of performance and risk analysis tools that can be applied to produce consistent results across different analytical processes Ability to perform point in time, single period, and multi-period portfolio performance and risk analyses using common assumptions and methodologies An open data model that meets the needs of all types of performance and risk analysis needs A single shared database where all portfolio, market, modeling, processing, and results data can be managed using a single set of data management tools Shared access to the same models and data by authorized users across an organization Scalability in performance and data management to meet the performance and risk analysis needs of any size organization These benefits allow clients to easily move from using KRM TP to another component of KRM or vice versa without the difficulty and complexity encountered in less integrated performance and risk solutions. 15

16 About Kamakura Corporation Founded in 1990, Kamakura Corporation is a leading provider of risk management information, processing and software. Kamakura has been a provider of daily default probabilities and default correlations for listed companies since November, Kamakura launched its collateralized debt obligation (CDO) pricing service KRIS-CDO in April Kamakura is also the first company in the world to develop and install a fully integrated enterprise risk management system that analyzes credit risk, market risk, asset and liability management, transfer pricing, and capital allocation. Kamakura has served more than 185 clients ranging in size from $3 billion in assets to $1.6 trillion in assets. Kamakura s risk management products are currently used in 27 countries, Kamakura has world-wide distribution alliances with Fiserv ( Unisys (www. unisys.com), and Zylog Systems ( making Kamakura products available in almost every major city around the globe Kalakaua Avenue, 14th Floor Honolulu, Hawaii United States of America Telephone: Facsimile: Information: info@kamakuraco.com 16