Foreign exchange risk formula
Seems the formula has been changed? I remember previously it was 10%*max(NSP-CO, 0), now the CO is removed?
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Seems the formula has been changed? I remember previously it was 10%*max(NSP-CO, 0), now the CO is removed?
Comments
I agree, this seems odd to me as well. I saw that section 5.2.2 has been removed but I feel this just makes it more confusing.
In 5.2.1, the paper states "adjusted by effective allowable foreign exchange rate hedges if any are used". So firstly, we wouldn't need to remember what adjustments are to be made because those are mentioned in the excluded 5.2.2 section. Moreover, the carve-out is not included in 5.2.2 step 1 adjustments as it has it's own section in 5.2.2 (it still seems to me that the carve-out is an adjustment to the capital required...). But then if the carve-out is not an adjustment, how come it's not mentioned separately in 5.2.1?
My apologies for changing the presentation in the web-based problem for foreign exchange risk in the market risk problem. I realize that's irritating and frustrating. Here's my chain of reasoning.
The answer in the examiner's report for the 2018 problem (link below) is technically wrong because they do not consider the carve-out. Now, I didn't want to include the wrong calculation in the web-based problem so I continued including the carve-out formulas from section 5.2.2 even though section 5.2.2 is specifically excluded from the syllabus. Based on other questions I received through the forum and email however, I finally decided it was better to get rid of all references to section 5.2.2.
Based on these 2 recent exam problems, the calculation for foreign exchange risk should be very easy on future exams:
In the 2018 problem they give you the long positions and all you have to do is multiply by 10% to get the capital required. (They don't give you enough information to calculate the carve-out). And in the 2019 problem, they give you the capital required for foreign exchange risk directly so you don't have to calculate anything. I believe this is what the examiners intend to do going forward.
Basically, I think they just want you to know that foreign exchange risk is part of the market risk calculation but they don't require you to know how to do the full detailed calculation. Just to emphasize, I think they will most likely provide the capital required for foreign exchange risk directly so that all you have to do is remember to include it as part of the total for market risk.
Let's hope so! Thank you Graham.
Can CapReq(Foreign Exchange) be negative? - say it's short position? - do we judgementally floor it at 0
I don't believe capital required for an MCT component can ever be negative. Even if it isn't specifically floored at 0, I believe that's what you should always do.