Razor Risk Market Risk Overview

Razor Risk Market Risk Overview Version 1.0 (Final) Prepared by: Razor Risk Updated: 20 April 2012

Razor Risk 7 th Floor, Becket House 36 Old Jewry London EC2R 8DD Telephone: +44 20 3194 2564 e-mail: peter.walsh@razor-risk.com 1 M A R K E T R ISK O V E R V I E W 1 2 V A L U E A T R I S K C A L C U L A T I O N 2 2.1 Historical Simulation 2 2.2 VaR Break-down 2 2.3 Specific Risk 4 2.4 Partial Risk 4 www.razor-risk.com 3 R E P O R T I N G, D R I L L - D O W N A N D W H A T - I F F U N C T I O N A L I T Y 5 3.1 Transaction Level Drill-downs 5 3.2 Greeks and OLAP Reporting 7 3.3 Razor Risk what-if functionality 8 4 M A R K E T R ISK W O R K F L O W 8 4.1 Incremental Processing 9 5 S C E N A R I O A N A L Y S I S 10 5.1 Scenario Analysis Functional 10 6 E X T E N D I B I L I T Y 11 7 L I Q U I D I T Y A N D F U N D I N G R I S K 11 8 B A C K - T E S T I N G 11 Created: 2009-02-27 Updated: 2012-04-20 Version: 1.0

1 M A R K E T R I S K O V E R V I E W Razor Risk s Market Risk module provides comprehensive market risk functionality to enable a large financial institution to fully meet internal and regulatory market risk management requirements. Razor Risk s Market Risk module is fully integrated with Razor Risk s Credit Risk and Limit Management modules. These modules all perform from a single trade repository, enabling integrated Market and Credit risk management. The Razor Risk Market Risk module includes the following functionality: Value at Risk Calculation Historical Simulation Monte Carlo Simulation Credit VaR Specific Risk Partial Risk Reporting, Drill-down and What-if Analysis Extensive Market Risk reporting withinrazor Risk OLAP reporting for sensitivity analysis Capability to develop external reports on the Razor Risk results. Full drill-down to the Transaction or Scenario detail to analyse all Market Risk results What-if analysis for new, amended or deleted trades Market-Risk workflow Base-lining of new VaR results to a previous base-line Incremental processing of any amendments for real-time VaR analysis Full audit trail and logging of all aspects of the Market Risk calculation Scenario Analysis Extendibility Pre-defined scenarios User-defined scenarios Stress Testing New pricing models or products can be added to the calculation Results can be aggregated externally to Razor Risk and aggregated into the overall calculation Liquidity and Funding Risk Back-testing Reporting of all cash flows by currency for all deals Inclusion/Exclusion of interim coupons Back-testing of VaR results to validation model Back-testing against Theoretical P/L (calculated by Razor Risk ) Back-testing against Actual P/L (fed to Razor Risk ) 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 1 of 14

2 V A L U E A T R I S K C A L C U L A T I O N Razor Risk supports Historical and Monte Carlo Simulation for VaR calculation. Both methodologies leverage therazor Risk distributed architecture which enables the calculations to be performed quickly and accurately. Razor Risk uses full revaluation of trades for calculation of VaR for both methodologies. The time horizon, confidence interval, base currency and number of scenarios is configurable for both methodologies. Confidence interval, base currency and time horizon is defined at the portfolio level, so different settings can be used for different portfolios. Razor Risk s portfolio aggregation capability enables users to drill down to any desired aggregation level. Examples are currency, product type, risk type, business unit or combinations of any of these. These aggregation levels are user-definable, and we have no pre-conceived notion of hierarchies inherent to our data design. Razor Risk supports full drill-down down to the transaction level to determine contribution to the overall risk results. Razor Risk also enables VaR results at any aggregation level to be compared against a baseline set of VaR results. This simplifies significantly the validation of VaR results on a daily basis. VaR results are stored in the Razor Risk database from where they are accessible for back-testing and historical reporting purposes. Razor Risk supports overnight, intra-day and near real-time calculation and reporting of VaR. Razor Risk has been designed to provide excellent performance to enable the calculation of VaR in real-time. Our distributed processing architecture enables full, sub-second Historical and Monte Carlo simulation using an affordable technology platform, and these response times include the application of any portfolio effects. The distribution of analytics and portfolio aggregations across multiple servers enables Razor Risk to cache the trade data and all calculated values across each server. Razor Risk leverages this when adding incremental trades, performing what-if analysis, and during pre-deal check functionality. Razor Risk analytics also leverage data caching for intermediate pricing data such as discount factors and hazard rates. On a given path and a given aggregation node, the discount factors for a particular yield curve need only be calculated once, and these factors are cached and used to price all trades corresponding to that curve. 2.1 HISTORICAL SIMULATION Razor Risk s HSVaR methodology supports the full revaluation of all transactions. Razor Risk s high performance architecture provides the processing capability to complete VaR calculations on large portfolios (50 to 150,000 transactions) in less than 10 minutes. Razor Risk supports turning portfolio transitioning on and off. This is configurable parameter for each risk calculation, and the Historical simulation period in Razor Risk is configurable. 2.2 VAR BREAK-DOWN Razor Risk supports the calculation and reporting of VaR at any aggregation level. These aggregation levels are user configurable. Razor Risk s VaR calculation revalues each transaction for each scenario. Once this task has been completed, Razor Risk aggregates the individual transaction results into the relevant portfolios. This approach ensures all the portfolio effects are captured for each portfolio, but maintains the efficiencies of only pricing each trade once - regardless of the number of portfolios in the system. Razor Risk s partial risk functionality enables VaR to be calculated for specific risk classes. Each market data input can be assigned to a Risk Class, as this is also user configurable. When calculating the contribution towards VaR for a specific risk class, only historical data for the required risk class is used, and the other risk classes are kept constant. Effects from combinations of risk classes can also be calculated and reported. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 2 of 14

Partial Risk by Risk Type Risk can also be reported by Geographical Location. A Location hierarchy can be defined in Razor Risk which breaks down Locations into Regions and then into specific trading centres. The booking location for a trade is then determined and VaR is aggregated for that trade based upon the location hierarchy. Similarly, risk can be broken down by Profit Centre by defining an internal unit hierarchy which mirrors the organisation s internal structure and aggregating risk to the appropriate Profit Centre based upon the internal unit the trade was booked through. The same approach is used for calculating risk from the Trading and Banking Book. Limits and limit utilisation can be measured for any portfolio aggregation defined within Razor Risk. Razor Risk can be configured to trigger an excess event when a portfolio threshold is breached. All Razor Risk VaR results can be reported in either tabular or graphical format. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 3 of 14

VaR Drill Down in Razor Risk 2.3 SPECIFIC RISK Razor Risk provides two choices for the calculation of Specific Risk 2.3.1 Credit Migration Model Razor Risk supports the modelling of credit migration behaviour of issuers or individual issues. Issues are first mapped to the appropriate credit spread curve. The mapping is configurable but common approaches are to map the issue based on Industry Sector and Credit Rating. A Mark to Market factor can be calculated in Razor Risk from the current market price of each issue. The MTM factor can be used to calibrate the pricing of the individual issue to the price predicted by the spread curve. Credit VaR is then calculated based upon the historical volatility and correlation of each curve. Credit Rating Migration can also be modelled in Razor Risk to capture price changes and any losses resulting from migration of credit ratings. Razor Risk simulates the rating migration behaviour of each curve based upon transition probabilities. If a rating migrates to default then a recovery model can be incorporated into the calculation to determine any losses. This approach provides a very sophisticated mechanism to calculate specific risk. 2.3.2 Standard Model Razor Risk can be configured to support the standard model calculation of specific risk as specified in the Basel Market Risk regulatory requirements. With the Standard Model specific weightings are applied against positions in individual issues to calculate the risk. Razor Risk can be configured to determine the appropriate weighting based upon the Standard Model requirements. 2.4 PARTIAL RISK Razor Risk s partial risk and drill down functionality provides the ability to decompose VaR into each of its components. This enables VaR to be isolated to Interest Rate, FX, Equity or Volatility risk. Users can define which sources of risk should be isolated in the partial risk calculation. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 4 of 14

3 R E P O R T I N G, D R I L L - D O W N A N D W H A T - I F F U N C T I O N A L I T Y Razor Risk provides extensive reporting and drill-down functionality. The following screenshots provide examples of the sort of information that is available through either the Razor Risk client applications or external applications. The following screenshot illustrates the output for a VaR distribution. From this histogram it is possible to select a single scenario of interest, and to view the trade contributions for that scenario. So for example From this frame the user may select an individual trade contribution of interest and view the details of the selected trade in the deal entry screen. 3.1 TRANSACTION LEVEL DRILL-DOWNS Razor Risk provides extensive drill-down capability to the transaction level. The contribution of each trade at the transaction level can be viewed in either tabular or graphical form. The diagram below provides an example of the transaction level drill-down supported by Razor Risk. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 5 of 14

Razor Risk Trade Contributions It is also possible to drill-down into each individual scenario to view the market data changes associated with each scenario, and the contribution of each trade to the results of the scenario. Perturbed Input Points for Scenario 11 in 1 Day MC VaR. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 6 of 14

For another scenario, the generated discount factors for scenario 6 for 1 day MC VaR. 3.2 GREEKS AND OLAP REPORTING 3.2.1 Greeks Greeks are calculated within Razor Risk as part of the Scenario Analysis. The Scenario Analysis functionality enables sensitivity scenarios to be defined for any input market data including spread curves for Credit Delta calculation. Razor Risk displays the scenario analysis results in a 2- dimensional form for each portfolio, and also within an OLAP based reporting capability for sensitivity results which produces a multi-dimensional output set that can easily be aggregated by any selected dimension to report the required risk measure. Razor Risk OLAP Scenario Reporting 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 7 of 14

3.3 RAZOR RISK WHAT-IF FUNCTIONALITY Razor Risk provides extensive what-if capability which is used in conjunction with the trade level drill-down. Razor Risk allows the user to view all data with and without the effect of the current what-if scenario and switch between the two views or view the before and after side by side. The effect of the what-if scenario on limits can be presented in tabular form, as absolute exposures or as the changes between exposures. It can also be shown graphically, via before and after graphs, or as composite graphs showing the net effect of the scenario. The user can enter a single deal, construct a structured deal using individual trade components, or enter a number of independent deals as part of a single scenario. Each scenario can be constructed from a mixture of: inserting new deals, either through manual entry or through copying an existing deal and amending it amendment of existing deals cancellation of existing deals The effect of the what-if scenario is applied to all portfolios in the system and is not constrained to any one portfolio. All calculations are performed in real-time and include the full processing of the Historical/Monte Carlo simulation giving rise to the full range of portfolio effects. Individual what-if scenarios can be named and saved, and restored at any time by the user. These scenarios can also be shared between users of the system so that several users can collaborate in the generation and analysis of a single scenario. The user can load multiple scenarios and switch between them at will, as well as copy data between scenarios. All drill-down and what-if results can be exported from Razor Risk to external applications as either XML, or can simply be cut and paste to Excel. Additionally the 2010 Excel Ribbon application can be used to further analyse Razor Risk output data. 4 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 8 of 14

M A R K E T R I S K W O R K F L O W Razor Risk provides extensive support to enable risk managers to quickly isolate sources of VaR or other Market Risk discrepancies to reduce the amount of time and effort that is required to produce accurate, validated market risk results. Razor Risk enables VaR results from any portfolio aggregation to be compared against a previously defined baseline to assist in isolating any changes in VaR. Baseline changes are shown in a graphical form and support full drill-down to determine the source of the VaR changes. Today s partial risk breakdown Comparison to yesterday s baseline 4.1 INCREMENTAL PROCESSING Razor Risk s incremental processing enables the impact of any deal amendments to be quickly modelled in the system without having to perform time consuming reruns of VaR results. The simulated valuations calculated by the pricing servers are stored within each portfolio aggregation server across all paths and all aggregation nodes. When evaluating incremental trades, only the new trade(s) are priced and the results are re-aggregated with the existing portfolio and the new exposure is calculated. Razor Risk does not have to re-calculate the entire portfolio when evaluating the effects of new trades on an existing portfolio. This approach significantly reduces the manpower and time required to produce accurate daily VaR results. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 9 of 14

5 S C E N A R I O A N A L Y S I S 5.1 SCENARIO ANALYSIS FUNCTIONAL Full Scenario Analysis and Stress Testing functionality is provided in Razor Risk as part of the Scenario Analysis functionality. Razor Risk s Scenario Analysis provides full access to Razor Risk Risk s market data set. Stress Tests are defined by applying changes to the market data set and applying these changes against the portfolio. These stress tests are then applied as part of the Turn of Day process, or run intra-day as required. There is no limit on the number and complexity of stress tests that can be defined. Razor Risk s pricing models also output additional trading risk analytics, such as greeks, PV01, modified duration, macaulay duration, convexity, clean price and accrued interest. Stress Testing Granularity - Stress Tests can be run at any portfolio level, in the same manner as VaR or Credit Risk calculations. Full drill-down into the stress test results is supported down to the transaction level. Shocks can be applied as either: FACTOR - factor to multiply the current market by ABSOLUTE - additive/subtractive value to add to the current market OUTRIGHT - a specific value to be set (current market has no impact) Additional analyses can also be performed on the results of the stress test. Razor Risk Scenario Edit Frame A canned set of stress tests can be defined and applied to the current market data set in line with the G30 standards. The frequency with which these stress tests can be run can also be specified (e.g. Daily, Weekly etc.) Historical stress tests based on specific historical events can also be set-up (e.g. ERM crisis, stock market crashes etc.) User-defined stress tests user defined stress tests are fully supported in Razor Risk. As well as stressing any of the input market data, it is also possible to change parameters of the Monte Carlo simulation to determine the impact on portfolio risk (e.g. modelling changes to mean reversion or changes to volatility or correlation of input rates). All Stress Tests in Razor Risk are defined and stored in the Razor Risk Database. To conduct a stress test the name of the stress test and the portfolio(s) against which it should be run are specified. Stress Tests can be run either as part of Turn of Day process or Intra-day as required. The Stress 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 10 of 14

Tests are run in the same manner as any other type of risk analysis in Razor Risk. Razor Risk enables Stress Tests to be automatically run at the same time as a VaR or Credit Risk analysis so there is no additional operational effort associated with performing stress tests. Different Stress Tests can also be scheduled to run on a periodic basis (e.g. Regulatory Stress Tests once a week, Internal Stress Tests on a daily basis, etc.). Limits can be set on stress tests in exactly the same manner that limits can be set on VaR or Credit Risk results. Razor Risk s limit management module is used to define the limits and to monitor limit utilisation. If utilisation exceeds the available limit then an excess is raised. All stress test results can be exported from Razor Risk to external applications as either XML, or cut and paste to Excel. 6 E X T E N D I B I L I T Y The analytics of Razor Risk s Market Risk module are fully extendible, so a client can incorporate their own analytics. Areas of extendibility include: Incorporation of a client or a third party s own pricing models Extension of product coverage by providing new pricing models and additional screens Inclusion of proprietary term structure generation routines Results can be aggregated externally to Razor Risk and aggregated into the overall calculation 7 L I Q U I D I T Y A N D F U N D I N G R I SK Razor Risk s liquidity risk functionality enables the risk for all daily portfolio cash flows, including coupons, to be measured and reported. This information can be broken down by currency and limits can be set on daily cash flow amounts. Razor Risk can also easily be extended by the client to incorporate a proprietary liquidity model. Other Razor Risk clients have adopted this approach to incorporate their own proprietary liquidity model into the system. 8 B A C K - T E S T I N G Back-testing is performed in Razor Risk in line with the BIS Internal model guidelines. Razor Risk calculates Theoretical P/L which is then compared against the relevant VaR results on a daily basis. Any exceptions are recorded and highlighted graphically by displaying a different colour. Razor Risk also supports back-testing against Actual P/L. The actual P/L results are fed to Razor Risk from an external system, and Razor Risk compares the VaR results against the actual P/L. The graph below shows the graphical and tabular representation of back test results for a particular portfolio in Razor Risk. The Theoretical and Actual P/L are shown plotted against the 99% 1 day VaR for the portfolio. The magnitude and frequency of excesses is reported in Razor Risk, and back-testing can be performed for any portfolio in the system such as business centre or desk. Expected tail gains and losses are calculated as part of the VaR analysis. This information is plotted in Razor Risk can be easily extracted into Excel. 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 11 of 14

Back Testing in Razor Risk 2012 TMX Technology Solutions- Razor Risk Commercial in Confidence Page 12 of 14