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## Notes to the financial statements 

for the financial year ended 31 March 2014 

continued 

## Note 38.3 Market risk 

Market risk is the exposure to adverse changes in the value of the Consolidated Entity's trading portfolios as a result of changes in market prices or volatility. The Consolidated Entity is exposed to the following risks in each of the major markets in which it trades: 

– foreign exchange and bullion:  changes in spot and forward exchange rates and bullion prices and the volatility of exchange rates and bullion prices; 

– interest rates and debt securities:  changes in the level, shape and volatility of yield curves, the basis between different debt securities and derivatives and credit margins; 

– equities:  changes in the price and volatility of individual equities, equity baskets and equity indices, including the risks arising from equity underwriting activity; and 

– commodities and energy: changes in the price and volatility of base metals, agricultural commodities and energy products; and to the correlation of market prices and rates within and across markets. 

It is recognised that all trading activities contain calculated elements of risk taking. The Consolidated Entity is prepared to accept such risks provided they are within agreed limits, independently and correctly identified, calculated and monitored by RMG, and reported to senior management on a regular basis. 

RMG monitors positions within the Consolidated Entity according to a limit structure which sets limits for all exposures in all markets. Limits are for both individual trading desks and divisions as well as in aggregate. Trigger limits for the Consolidated Entity as a whole ensure that if several trading book limits are being used simultaneously, the aggregate level of risk is in line with the global risk appetite articulated in the economic capital model. 

RMG sets three complementary limit structures: 

– contingent loss limits : worst case scenarios that shock prices and volatilities by more than has occurred historically. Multiple scenarios are set for each market to capture the non-linearity and complexity of exposures arising from derivatives. A wide range of assumptions about the correlations between markets is applied; 

– position limits:  volume, maturity and open position limits are set on a large number of market instruments and securities in order to constrain concentration risk and to avoid the accumulation of risky, illiquid positions; and 

– Value-at-Risk (VaR) limits:  statistical measure based on a 10-day holding period and a 99 per cent confidence level, as stipulated by the APRA capital adequacy standard. The model is validated daily by back testing a one-day VaR against hypothetical and actual daily trading profit or loss. 

## Value-at-Risk (VaR) figures (1-day, 99 per cent confidence level) 

The table below shows the average, maximum and minimum VaR over the year for the major markets in which the Consolidated Entity operates. The VaR shown in the table is based on a one-day holding period. The aggregated VaR is on a correlated basis. 

<img src='content_image/240693.jpg'>

Value-at-Risk 

The VaR model uses a Monte Carlo simulation to generate normally distributed price and volatility paths, based on three years of historical data. VaR focuses on unexceptional price moves so that it does not account for losses that could occur beyond the 99 per cent level of confidence. These factors can limit the effectiveness of VaR in predicting future price moves when changes to future risk factors deviate from the movements expected by the above assumptions. For capital adequacy purposes, debt-specific risk is measured using APRA’s standard method, whilst all other exposures are captured by the VaR model. This combined approach has been approved by APRA and is subject to periodic review. 

Interest rate risk 

The Consolidated Entity also has exposure to non-traded interest rate risk generated by banking products such as loans and deposits. Banking businesses have small limits to accumulate small levels of interest rate risk. Wherever possible, these interest rate risks are transferred into the trading books of FICC and Group Treasury which are managed within traded market risk limits and are included within the VaR figures presented above. Some residual interest rate risks remain in the banking book. These residual risks have independent limits that are monitored by RMG. 

