2011 Annual Report - BDO

NOTES TOFINANCIAL STATEMENTSpotential losses in the Bank’s portfolios exceed tolerable levels.Because the VaR measure is tied to market volatility, it therefore allows management to reactquickly and adjust its portfolio strategies in different market conditions in accordance with itsrisk philosophy and appetite. The VaR model is validated through back-testing.Although VaR is an important tool for measuring market risk, the assumptions on which themodel 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 of positions withinthat period. This is considered to be a realistic assumption in almost all cases but may notbe the case in situations in which there is severe market illiquidity for a prolonged period.• A 99% confidence level does not reflect losses that may occur beyond this level. Evenwithin the model used, there is a one percent probability that losses could exceed the VaR.• VaR is calculated on an end-of-day basis and does not reflect exposures that may arise onpositions during the trading day.• The use of historical data as a basis for determining the possible range of future outcomesmay not always cover all possible scenarios, especially those of an exceptional nature.• The VaR measure is dependent upon the Bank’s position and the volatility of marketprices. The VaR of an unchanged position reduces if the market price volatility declinesand 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 wide rangeof stress tests to model the financial impact of a variety of exceptional market scenarios onindividual trading portfolios and the Bank’s overall position.Stress VaR is also performed on all portfolios as a complementary measure of risk. While VaRdeals with risk during times of normality, stress testing is used to measure the potential effectof a crisis or low probability event.A summary of the VaR position of the Bank’s trading portfolios as at December 31, 2011 and2010 follows:2011 2010VaR Stress VaR VaR Stress VaRForeign currency risk P 41,258 P 265,114 P 639,978 P 5,101,792Interest rate risk – Peso 9,059,773 55,984,801 11,608,481 161,784,819Interest rate risk – USD 4,519,124 98,241,660 5,723,084 108,415,02613,620,155 P 154,491,575 P 17,971,543 P 275,301,637