Bank of Montreal 2008 Annual Report Download - page 159

BMO Financial Group 191st Annual Report 2008 | 155
Swaps are contractual agreements
between two parties to exchange
a series of cash flows. The various
swap agreements that we enter
into are as follows:
• Commodity swaps –counterparties
generally exchange fixed and floating
rate payments based on a notional
value of a single commodity.
• Credit default swaps –one counter-
party pays the other a fee in
exchange for that other counterparty
agreeing to make a payment
if a credit event occurs, such as
bankruptcy or failure to pay.
• Cross-currency interest rate swaps –
fixed and floating rate interest
payments and principal amounts are
exchanged in different currencies.
• Cross-currency swaps –fixed rate
interest payments and principal
amounts are exchanged in different
currencies.
• Equity swaps –counterparties
exchange the return on an equity
security or a group of equity securities
for the return based on a fixed or
floating interest rate or the return on
another equity security or group of
equity securities.
• Interest rate swaps –counterparties
generally exchange fixed and floating
rate interest payments based on a
notional value in a single currency.
Taxable Equivalent Basis (teb):
Revenues of operating groups reflected
in our MD&A are presented on
a taxable equivalent basis (teb).
The teb adjustment increases GAAP
revenues and the provision for
income taxes by an amount that
would increase revenues on certain
tax-exempt securities to a level
that would incur tax at the statutory
rate, to facilitate comparisons.
Tier 1 Capital represents more
permanent forms of capital, and
primarily consists of common share-
holders’ equity, preferred shares
and innovative hybrid instruments,
less a deduction for goodwill and
excess intangible assets and certain
other deductions required under
Basel II.
Tier 1 Capital Ratio is defined as Tier 1
capital divided by risk-weighted assets.
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Total Capital includes Tier 1 and Tier 2
capital, net of certain deductions.
Tier 2 capital is primarily comprised
of subordinated debentures and
the eligible portion of the general
allowance for credit losses. Deductions
from Tier 2 capital are primarily
comprised of our investments in
non-consolidated subsidiaries and
other substantial investments.
Total Capital Ratio is defined as total
capital divided by risk-weighted assets.
Total Shareholder Return (TSR):
The five-year average annual total
shareholder return (TSR) represents
the average annual total return earned
on an investment in BMO common
shares made at the beginning of a
five-year period. The return includes the
change in share price and assumes that
dividends received were reinvested
in additional common shares. The one-
year TSR also assumes that dividends
were reinvested in shares.
Trading-Related Revenues include
net interest income and non-interest
revenue earned from on and off-balance
sheet positions undertaken for trading
purposes. The management of
these positions typically includes
marking them to market on a daily
basis. Trading revenues include
income (expense) and gains (losses)
from both on-balance sheet instru-
ments and off-balance sheet interest
rate, foreign exchange (including
spot positions), equity, commodity
and credit contracts.
Variable Interest Entities (VIEs)
include entities with equity that is
considered insufficient to finance the
entity’s activities or in which the equity
holders do not have a controlling
financial interest. We are required to
consolidate VIEs if the investments
we hold in these entities and/or the
relationships we have with them result
in us being exposed to the majority
of their expected losses, being able
to benefit from a majority of their
expected residual returns, or both,
based on a calculation determined
by standard setters.
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Business Risk Due to Earnings
Volatility arises from the specific
business activities of a company
and the effects these could have
on the earnings of the company.
Business risk due to earnings volatility
measures the risk that volumes
will decrease or margins will shrink
with no opportunity being available
to offset the revenue declines
with a reduction in costs.
Credit and Counterparty Risk is the
potential for loss due to the failure
of a borrower, endorser, guarantor
or counterparty to repay a loan
or honour another predetermined
financial obligation.
Earnings Volatility (EV) is a measure
of the adverse impact of potential
changes in market parameters on
the projected 12-month after-tax
net income of a portfolio of assets,
liabilities and off-balance sheet
positions, measured at a 99%
confidence level over a specified
holding period.
Economic Capital is our internal
assessment of the risks underlying
BMO’s business activities. It represents
management’s estimation of the
likely magnitude of economic losses
that could occur if adverse situations
arise, and allows returns to be
adjusted for risks. Economic capital
is calculated for various types of risk
–credit, market (trading and non-
trading), operational and business
–where measures are based on a
time horizon of one year. (For further
discussion of these risks, refer to the
Enterprise-Wide Risk Management
section on page 73.) Economic capital
is a key element of our risk-based
capital management process.
Environmental Risk is the risk of
loss or damage to BMO’s reputation
resulting from environmental concerns
related to BMO or its customers.
Environmental risk is often associated
with credit and operational risk.
Issuer Risk arises in BMO’s trading
and underwriting portfolios,
and measures the adverse impact
of credit spread, credit migration
and default risks on the market
value of fixed income instruments
and similar securities. Issuer risk
is measured at a 99% confidence
level over a specified holding period.
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Liquidity and Funding Risk is
the potential for loss if BMO is unable
to meet financial commitments
in a timely manner at reasonable
prices as they fall due. Financial
commitments include liabilities
to depositors and suppliers,
and lending, investment and
pledging commitments.
Market Risk is the potential
for a negative impact on the balance
sheet and/or income statement
resulting from adverse changes
in the value of financial instruments
as a result of changes in certain
market variables. These variables
include interest rates, foreign
exchange rates, equity and commod-
ity prices and their implied volatilities,
as well as credit spreads, credit
migration and default.
Market Value Exposure (MVE)
is a measure of the adverse impact
of changes in market parameters
on the market value of a portfolio
of assets, liabilities and off-balance
sheet positions, measured at a
99% confidence level over a specified
holding period. The holding period
considers current market conditions
and the composition of the portfolios
to determine how long it would take
to neutralize the market risk without
adversely affecting market prices.
For trading and underwriting
activities, MVE is comprised of
Value at Risk and Issuer Risk.
Operational Risk is the potential
for loss resulting from inadequate or
failed internal processes or systems,
human interactions or external
events, but excludes business risk.
Reputation Risk is the risk of
negative impacts resulting from the
deterioration of BMO’s reputation
with key stakeholders. These impacts
include revenue loss, reductions
in our customer or client base and
declines in BMO’s share price.
Value at Risk (VaR) is measured
for specific classes of risk in BMO’s
trading and underwriting activities:
interest rate, foreign exchange
rate, equity and commodity prices
and their implied volatilities. This
measure calculates the maximum
likely loss from portfolios, measured
at a 99% confidence level over a
specified holding period.
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RISK-RELATED DEFINITIONS