TD Bank 2006 Annual Report Download - page 65

TD BANK FINANCIAL GROUP ANNUAL REPORT 2006 Management’s Discussion and Analysis 61
•Arbitrage: We take positions in certain markets or products
and offset the risk in other markets or products. Our knowl-
edge of various markets and products and how they relate
to one another allows us to identify and benefit from pricing
anomalies.
•Positioning: We aim to make profits by taking positions in
certain financial markets in anticipation of changes in those
markets. This is the riskiest of our trading activities and we
use it selectively.
WHO MANAGES MARKET RISK IN TRADING ACTIVITIES
Primary responsibility for managing market risk lies with
Wholesale Banking, with oversight from Trading Risk
Management within Risk Management.
The Market Risk and Capital Committee is chaired by the
Senior Vice President, Trading Risk Management and includes
members of senior management from Wholesale Banking and
Audit. They meet regularly to conduct a review of the market
risk profile of our trading businesses, approve changes to risk
policies, review underwriting inventories, and review the usage
of capital and assets in Wholesale Banking.
The Risk Committee of the Board oversees the management of
market risk and periodically approves all major market risk policies.
HOW WE MANAGE MARKET RISK
IN TRADING ACTIVITIES
Managing market risk is a key part of our business planning
process. We begin new trading operations or expand existing
ones only if the risk has been thoroughly assessed and is judged
to be within our risk tolerance and business expertise, and if the
appropriate infrastructureis in place to monitor, control and
manage the risk.
Trading Limits
Weset trading limits that areconsistent with the approved
business plan for each business and our tolerance for the market
risk of that business. In setting limits we take into account
market volatility,market liquidity, trader experience and business
strategy. Limits are prescribed at the desk level, portfolio level,
business line level and in Wholesale Banking in aggregate.
Our primary trading limits are sensitivity and specialized limits,
such as notional limits, credit spread limits, yield curve shift
limits, price and volatility shift limits. A variety of other limits are
also reviewed.
Another primary measure of trading limits is Value-at-Risk
(VaR). VaR measures the adverse impact that potential changes in
market rates and prices could have on the value of a portfolio
over a specified period of time. We use VaR to monitor and
control overall risk levels and to calculate the regulatory capital
required for market risk in trading activities.
At the end of each day, risk positions are compared with risk
limits and all instances where trading limits have been exceeded
are reported. Any excesses are escalated and managed according
to market risk policies and procedures. For selected high-impact
excesses, there is an immediate escalation process to the Chief
Risk Officer.
Calculating VaR
We estimate VaR by creating a distribution of potential changes
in the market value of the current portfolio. We value the current
portfolio using the most recent 251 trading days of market price
and rate changes. VaR is then computed as the threshold level
that portfolio losses are not expected to exceed more than one
out of every 100 trading days.
The graph below discloses daily VaR usage.1
1VaR data excludes TD Ameritrade.
Value-at-Risk
(millions of Canadian dollars)
VaR (General)
-20
0
-5
-10
-15
Feb
1/06
Mar
1/06
Apr
1/06
Jun
1/06
Jul
1/06
Aug
1/06
Sept
1/06
Oct
3/06
Oct
31/06
May
2/06
Jan
1/06
Dec
1/05
Nov
1/05
For the years ended October 31 2006 2005
(millions of Canadian dollars) Year-end Average High Low Year-end Average High Low
Interest rate risk $(4.0) $(8.2) $(14.0) $(3.5) $ (7.3) $(8.2) $(13.7) $(5.2)
Equity risk (6.0) (5.6) (10.8) (3.3) (5.5) (5.6) (10.0) (3.6)
Foreign exchange risk (1.2) (2.1) (4.4) (0.5) (1.9) (2.8) (6.2) (0.9)
Commodity risk (1.0) (1.3) (4.2) (0.4) (0.8) (1.0) (2.8) (0.4)
Diversification effect15.0 7.3 n/m2n/m24.8 8.1 n/m2n/m2
General Market Value-at-Risk $(7.2) $(9.9) $(14.8) $(6.2) $(10.7) $(9.5) $(15.8) $(5.9)
VALUE-AT-RISK
TABLE 3 5
1The aggregate VaR is less than the sum of the VaR of the different risk
types due to risk offsets resulting from portfolio diversification effect.
2Not meaningful. It is not meaningful to compute a diversification effect
because the high and low may occur on different days for different risk
types.
Stress Testing
Our trading business is subject to an overall global stress test
limit. As well, each global business has a stress test limit, and
each broad risk class has an overall stress test limit. Stress scenar-
ios are designed to model extreme economic events, replicate
worst-case historical experiences or introduce large but plausible
moves in key market risk factors.
Stress tests are produced and reviewed regularly with the
Chief Risk Officer, and with the Market Risk and Capital
Committee.
MARKET RISK IN INVESTMENT ACTIVITIES
Wearealso exposed to market risk in the Bank’sown investment
portfolio and in the merchant banking business. Risks are man-
aged through a variety of processes, including identification of
our specific risks and determining their potential impact. Policies
and procedures are established to monitor, measure and mitigate
those risks.