Via ODiSy March 22, 2012 PHILIPPINE STOCK EXCHANGE ... - BDO

- 55 -VaR is one of the key measures in BDO Unibank Group’s management of market risk.VaR is defined as a statistical estimate of the maximum possible loss on a given positionduring a time horizon within a given confidence interval. BDO Unibank Group uses a99% confidence level and a 260-day observation period in VaR calculation. BDOUnibank Group’s VaR limit is established as a percentage of projected earnings and isused to alert senior management whenever the potential losses in BDO UnibankGroup’s portfolios exceed tolerable levels. Because the VaR measure is tied to marketvolatility, it therefore allows management to react quickly and adjust its portfoliostrategies in different market conditions in accordance with its risk philosophy andappetite. The VaR model is validated through back-testing.Although VaR is an important tool for measuring market risk, the assumptions onwhich the model is based do give rise to some limitations, including the following:• A 1-day holding period assumes that it is possible to hedge or dispose ofpositions within that period. This is considered to be a realistic assumption inalmost all cases but may not be the case in situations in which there is severemarket illiquidity for a prolonged period;• A 99% confidence level does not reflect losses that may occur beyond this level.Even within the model used, there is a one percent probability that losses couldexceed the VaR;• VaR is calculated on an end-of-day basis and does not reflect exposures thatmay arise on positions during the trading day;• The use of historical data as a basis for determining the possible range of futureoutcomes may not always cover all possible scenarios, especially those of anexceptional nature; and,• The VaR measure is dependent upon BDO Unibank Group’s position and thevolatility of market prices. The VaR of an unchanged position reduces if themarket price volatility declines and vice-versa.The limitations of the VaR methodology are recognized by supplementing VaR limitswith other position and sensitivity limit structures, including limits to address potentialconcentration risks within each trading portfolio. In addition, the Bank uses a widerange of stress tests to model the financial impact of a variety of exceptional marketscenarios on individual trading portfolios and the Bank’s overall position. Stress VaR isalso performed on all portfolios as a complementary measure of risk. While VaR dealswith risk during times of normality, stress testing is used to measure the potential effectof a crisis or low probability event.