2011 Annual Report Financial Supplements - BDO

NOTES TOFINANCIAL STATEMENTSDECEMBER 31, 2011, 2010 AND 2009(Amounts in Millions of Philippine Pesos, Except Per Share Data or As Indicated)VaR is one of the key measures in BDO Unibank Group’s management of market risk. VaRis defined as a statistical estimate of the maximum possible loss on a given position during atime horizon within a given confidence interval. BDO Unibank Group uses a 99%confidence level and a 260-day observation period in VaR calculation. BDO UnibankGroup’s VaR limit is established as a percentage of projected earnings and is used to alertsenior management whenever the potential losses in BDO Unibank Group’s portfolios exceedtolerable levels. Because the VaR measure is tied to market volatility, it therefore allowsmanagement to react quickly and adjust its portfolio strategies in different market conditionsin accordance with its risk philosophy and appetite. The VaR model is validated throughback-testing.Although VaR is an important tool for measuring market risk, the assumptions on which themodel is based do give rise to some limitations, including the following:A 1-day holding period assumes that it is possible to hedge or dispose of positionswithin that period. This is considered to be a realistic assumption in almost all casesbut may not be the case in situations in which there is severe market illiquidity for aprolonged period;A 99% confidence level does not reflect losses that may occur beyond this level. Evenwithin the model used, there is a one percent probability that losses could exceed theVaR;VaR is calculated on an end-of-day basis and does not reflect exposures that may ariseon positions during the trading day;The use of historical data as a basis for determining the possible range of futureoutcomes may not always cover all possible scenarios, especially those of anexceptional nature; and,The VaR measure is dependent upon BDO Unibank Group’s position and thevolatility of market prices. The VaR of an unchanged position reduces if the marketprice volatility declines and vice-versa.The limitations of the VaR methodology are recognized by supplementing VaR limits withother position and sensitivity limit structures, including limits to address potentialconcentration risks within each trading portfolio. In addition, the Bank uses a wide range ofstress tests to model the financial impact of a variety of exceptional market scenarios onindividual trading portfolios and the Bank’s overall position. Stress VaR is also performed onall portfolios as a complementary measure of risk. While VaR deals with risk during times ofnormality, stress testing is used to measure the potential effect of a crisis or low probabilityevent.