2/28/2007
How is risk measured in unit-linked insurance operations?
Companies conducting unit-linked insurance operations should not include investment assets for which the policyholder carries the investment risk or technical provisions for life insurance for which the policyholder assumes the risk that is stressed tested. These items are excluded in the computation of the capital buffer.
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How is risk measured in hedge funds?
The risk in hedge funds, mixed funds, composite products and so forth is measured on the basis of the sensitivity to changes in each type of asset. The traffic light system measures the overall risk, and thus specific risk in these types of assets is not taken into consideration.
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How are hedge funds treated that can invest in equities, fixed-income instruments and currencies?
In this instance, the various assets must be divided up and stress tested together with other assets of the same type.
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How is a fund-of-funds in hedge funds treated?
Fund-of-funds is treated in the same manner as a normal hedge fund. Accordingly, you separate the assets into the respective asset classes.
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If a hedge fund or fund-of-funds of hedge funds cannot show how the assets’ value is affected by the stress test, how should it then be treated in terms of risk?
In general, assets that cannot be risk measured in the traffic light system are reported separately, for example, raw material derivatives and other assets that cannot be divided or distributed down to equities, fixed-income, real estate, credit or currency risks. It is planned that the final form will take into account reporting of these types of assets that cannot be measured in the traffic light model.
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How is risk measured in derivative products?
The risk in derivatives is calculated as the price change in each derivative product, given that the price for the underlying asset changes in line with the red scenario. The value change in an equity derivative as a result of the change in the underlying equity is thus included in the net risk for equities. This applies regardless of whether the purpose is purely speculative or is aimed at hedging risk. It is reasonable to assume that the assumptions regarding future volatility that provide the basis for certain derivatives are affected in the scenarios measured in the model. The companies may themselves make assumptions regarding these altered assumptions in the valuation of the derivative products.
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EUR swaptions emerge unfavorably through the use of the correlation assumption between the EUR interest rate and SEK interest rate. What’s your view on this?
We are aware of this. If this has a major impact on the measured results for any company, it can be highlighted in the explanation of why the company has a red light.
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How is the currency risk in interest swaps in another currency than SEK handled in the traffic light model?
The currency risk in such a swap is measured as the change in value of the swap as a result of a strengthening/weakening of the SEK rate. If there are other assets or undertakings in the same currency, the change (strengthening/weakening) in the SEK rate that is the least favorable for the company shall be tested. Accordingly, it is the net risk that guides the direction of the change in exchange rate. The currency risk is assumed to be independent of other risks. As a result, the currency risk is measured isolated from interest risk.
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Can you provide an example of how the risk in a swap or swaption should be calculated taking into account the interest risk attributable to a decline in the Swedish 10-year bond?
In the interest-risk exposure, you calculate how the swap’s (swaption’s) market value changes in the case of a decline (if you are short in interest risk) in all interests corresponding to 30 percent of the ten-year interest. In the credit risk, you calculate how the swap’s (swaption’s) market value changes due to the spread against risk-free interest deviating by 50 base points. These two events are assumed in the traffic light model to be independent, which is reflected in the square root formula used to weigh the same effect
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How is the credit risk in a swap stress tested?
In interest-bearing assets with credit/counterparty risk, the affect of an interest rate change is tested and the effect of a spread increase against the risk-free interest rate. These two events are assumed in the traffic light model to be independent, which is reflected in the square root formula used to weigh the same effect.
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With regards to equity/first loss tranches of Collateralised Debt Obligations ("CDOs") or other asset backed or repacked securities, is it correct to assume that this should be lumped together with equity holdings?
No. This is addressed in the reporting of interest risk. However, it is important to remember that the traffic light system is not designed to measure risk in all forms of assets or to measure the specific risk. In its supervisory role, FI is interested in the company’s actual risk exposure. A company that invests in these forms of assets should have internal models that can adequately measure the risk in the forms of investments.
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How do you evaluate the risk for an equity index bond?
You divide the risk into an interest portion and an equity portion. The risk in the equity portion is that this portion can be positive and then later weaken in a stress scenario.
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How do you handle credit risk and volatility risk in an equity index bond?
The credit risk is treated as other credit risk in the interest side. The company determines itself if it wants to make an assumption about changed volatility in calculating the share risk.
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How is risk treated in repo transactions? Is there a difference if the security is Swedish or foreign? Is there a difference if the term is short or long?
In a true repo, the transferring party continues to carry the security on the balance sheet as an asset. The purchase consideration for the spot transaction is reported in cash and a corresponding amount is reported as a liability. The difference between the selling price and repurchase price is distributed over the repo’s term and reported as interest expense and liability. Calculation of the interest risk is made taking into account the security, cash and liability. The receiving party books the purchase price as a reduction in cash and as a receivable. Calculation of the interest risk is based on the receivable.
The interest risk in the repo is divided into nominal interest risk, real interest risk and currency in the same manner as other interest risk. The interest risk in repos is affected by the term in the same manner as other interest risk.
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