SEPTEMBER 2016

Written By:
Joseph Fars
Jingweng Loh
Mikhil Mahore
Viara Marinova
Zhansaya Pazylbekova
Carlo Roco
Elham Saeedy
Divya Sarin
Narmin Sultanova

Notice to Participants
Are you looking for opportunities to broaden your insights in finance and risk management? Do you want to put theory
into practice and engage in important risk management conversations relevant to todays business environment? If your
answer is yes, we would like to invite you to the Capital Markets Risk Management Case Competition sponsored by TD
Securities!
THE CASE FIRST ROUND
You will be competing on behalf of your schools in teams of 3 to 5. You will be presented with a risk management case
study that will require your skills to learn, analyze, and evaluate risk management scenarios. Competing teams are
expected to formulate a written case study answer.
THE PRESENTATION SECOND ROUND
The top 5 teams selected from the first round will be provided with supplementary scenario based on their submitted
case and will be required to present their strategic recommendation and detailed action plan to a corporate judging panel.
Executive members from TD Capital Markets Risk Management will determine the winners for the final round.
Finalists will also be invited to a social networking event hosted by TD after presentations, offering the opportunity to
interact with your peers and to network with industry professionals and prospective employers.
GURANTEED INTERVIEW TO THE TD CAPITAL MARKETS RISK MANAGEMENT ASSOCIATE PROGRAM AND
DAY IN THE LIFE JOB SHADOW
Teams will be competing for prizes offered by TD Bank. The first place winners will get to experience A Day in the Life
of Capital Markets Risk Management, where they will spend one day shadowing with analysts from a variety of TD
Capital Markets Risk Management groups on the job. This is a perfect opportunity to see what it is like to work in risk
management in Capital Markets. In addition to the unique learning experience, each member in the top three ranking
teams will be guaranteed an interview for the Capital Markets Risk Management Summer associate program for 2017.

Table of Contents
1

Executive Summary ............................................................................................................................................... 4

1.1

Requirements ............................................................................................................................................ 4

1.2

Assumptions .............................................................................................................................................. 4

1.3

Format Specifications................................................................................................................................ 5

1.4

Due Date ................................................................................................................................................... 5

1.5

Collaboration and Plagiarism .................................................................................................................... 5

1.6

Acknowledgements ................................................................................................................................... 5

The CMRM Risk Management Case Study........................................................................................................... 6

2.1

Market Risk: Precious Metals PEST Analysis, Assessment of Risks, and Brexit Impact (25%) .............. 6

2.2

Credit Risk: Counter Party Credit Risk Analysis (15%) ............................................................................ 6

2.3

Market Risk: Black and Scholes (20%) ..................................................................................................... 7

2.4

Regulatory Risk: FRTB Impact on Risk Management (30%) .................................................................... 8

Appendices ........................................................................................................................................................... 10
3.1

Appendix A: Overview of the Metals Business* ...................................................................................... 10

3.2

Appendix B: Market Risk Commentary Example .................................................................................... 10

3.3

Appendix C: Introduction to FRTB .......................................................................................................... 10

Executive Summary

Looking at the current landscape, post financial crisis, one would observe a greater emphasis on the accountability,
transparency, and controls around how financial institutions conduct business. With Basel III's recommendations being
adopted by regulators globally, the Dodd-Frank Act and associated Volcker Rule coming into effect, stringent capital
requirements, and market news constantly highlighting economic uncertainty, the importance of Risk Management at
financial institutions has never been more prominent than today. Companies have been realigning their strategies to
support these changes and risk management has been at the forefront of every initiative.
It has now become necessary for individuals in the industry and aspiring candidates to start thinking as a Risk Manager.
Essential skills candidates must possess include the ability to take a 360-degree approach to decisions, the technical
skills to assess these risks, an understanding of the risk management framework, and an aptitude for executing change.
This case attempts to extract these skills, taking the candidates into the life of a rotational associate in the world of Capital
Markets Risk Management (CMRM). The case takes a top down approach beginning with an understanding of the
economic landscape and converges to different approaches to market risk, credit risk and regulatory risk.
For clarity, the case segments are broken down and provided on the table of contents below. When answering the case,
candidates must be able to communicate their arguments effectively and concisely, with supported technical knowledge
and independent research. On behalf of TD CMRM, we thank you for participating and we wish you the best of luck!

1.1

REQUIREMENTS
Assuming the role of a rotating associate in Capital Markets Risk Management (CMRM), teams are required to
review the case and provide responses to the questions in bold throughout the case. The requirements are
summarized below along with the weighting of the questions:

Analyze the precious metals industry globally and the impact on the metals business strategy. Prepare a
PEST analysis for the precious metals industry and identify 3 major risks worth discussing (25%)

Generate a quantitative analysis on credit risk exposure for a metals related counter party (15%)

Conduct a market risk analysis using Black and Scholes (20%)

Understand the impact of new regulations on market risk. FRTB is being implemented in global financial
institutions. With this implementation, infrastructure within institutions will change how risk is measured.
(30%)

The case writing is communicated effectively with a strong command of vocabulary and grammar,
organization, flow, and follows format specifications (10%)

Participants are expected to conduct external research using relevant resources on industries and markets for the
case study

Participants are expected to make connections to market risk, credit risk, and regulatory risk

Participants are expected to follow the format specifications outlined below

1.2

ASSUMPTIONS

Answer the questions to the best of your abilities. State your assumptions, however, assumptions must be logical.

1.3

FORMAT SPECIFICATIONS

The following format specifications will be accepted:

1.4

Groups will be expected to provide a maximum 12-page response and 2 page appendices to the case (if necessary).
The case will be in the following format:

Double spaced; portrait orientation; 1 inch margins

Arial; font size 12

All Excel appendices must be presented in Word. The figures in Excel must be scaled to 100% - maximum
2 pages

All sources are required to be cited in Chicago Style

All text in footnote and headers cannot be smaller than font size 8

DUE DATE

Deadline is October 2nd at 11:59PM

Teams are to submit their case study by email to CMRM-Outreach@tdsecurities.com

1.5

COLLABORATION AND PLAGIARISM

Each group should prepare and present an original response as a team

Researching from published materials and sharing ideas are encouraged. However, teams must appropriately
reference materials used (Chicago Style) in original writing

Plagiarism of any kind will not be tolerated. Violating these rules will disqualify your team from moving on to the next
round

1.6

ACKNOWLEDGEMENTS

We would like especially thank the following individuals for their contribution to the writing of this case:

Mojib Hakimzadah

Devin Lapierre

Anna Litvinova

Jonathan Patterson

Mark Song

Robert Weinman

The CMRM Risk Management Case Study

2.1

MARKET RISK: PRECIOUS METALS PEST ANALYSIS, ASSESSMENT OF RISKS, AND

BREXIT IMPACT (25%)

i.

Walter is a rotational associate starting his first rotation on May 1st 2016. Within this role, he is responsible for
reporting risk, specifically for the metals policy (Appendix A a business strategy overview). Other primary
responsibilities include generating a risk report and providing market risk commentary. To get an understanding of
the market, Walter's manager asks him to conduct a PEST analysis (political, economic, social, and technological
factors) of the precious metals industry globally over the last 2 years and identifying 3 major risks.

Develop a PEST analysis of the global precious metals industry over the last two years given Walter's role
began May 1st 2016.

Use your PEST analysis to identify three major risks related to global precious metals.

ii.

It is now June 24th 2016, the day after Brexit polls have closed. Walter observes the impact of Brexit on the metals
business and contemplates how this would impact the desk. As Walter's responsibilities include providing weekly
market commentary (Appendix B market commentary example), he decides to structure his commentary by taking
considerations on the below:

Write a market commentary for the week of Brexit.

Focusing on the precious metals business, describe 3 risks the desk will face due to the occurrence of
Brexit.

2.2

CREDIT RISK: COUNTER PARTY CREDIT RISK ANALYSIS (15%)

iii.

Sarah, a counterparty credit risk analyst, is reviewing the credit risk exposures that are currently inflicting the Desk.
She noted that a particular trade with Steel Inc. requires periodic review due to the impending Brexit vote. From her
understanding, Steel Inc is a manufacturer based in the Unites States and expected the delivery of equipment from
the UK. To hedge its long currency exposure, it entered into a 1-year currency forward contract at a rate of $1.76
for each British pound to be received at expiration covering 1 million British pounds. The US risk-free rate is 5.12%
and the UK risk-free rate is 6.23%, both compounded annually. With her current knowledge, she ponders on the
Desks credit risk exposure and attempts to answer some questions:

Suppose 6 months have passed since the initiation of the forward contract. Interest rates have remained
the same, but the spot rate is now $1.73. From the Desks perspective, what is the current credit risk
exposure associated with the forward contract position facing Steel Inc.?

Would marking-to-market the forward contract reduce the credit exposure of the Desk?

Consider instead that this forward contract is a fully-collateralized trade with a standard 10-day margin
period of risk, where the value of the forward contract and collateral offset to zero. Please explain why the
Desk is still exposed to credit risk.

2.3
iv.

MARKET RISK: BLACK AND SCHOLES (20%)

Sarah was tasked with an ad-hoc assignment to follow the price movements of Steel Inc. common stock and
calculate call and put prices. Sarah looked up the annualized rate for a Treasury bill expiring Feb 24, 2017 as 2.50%.
She then decided to look at historical closing prices of the last 100 trading days (Excel File - refer to data sheet
provided as a second attachment to email). Suspecting that Black Scholes is required, she glances at her CMRM
cheat sheet to check the formulas related to calculating call and put prices using the Black Scholes Merton Formula:

Somewhat flustered with how to approach the task, she reached out to Jack, a fellow rotational associate, who had
mentioned to find the Ln return (Ln (Pricet / Pricet-1) and estimate the daily volatility with the formula
Stdev(range of returns) in Excel. Jack also reminded Sarah to annualize the daily volatility estimate by multiplying
the square root of the number of trading days in the year (252).
Considering the call and put options, Sarah assumed that each option expired on Feb 24, 2017. Sarah's group
manager, James, wanted a specific spreadsheet template showing an "Input" heading with the following descriptions
in order to easily integrate into other team's template that share the same information; Stock Price Now ($44.11);
Standard Dev annual; Risk Free Rate annual; Exercise Price ($42); and Time to Maturity Years. In calculating
the time to maturity assume 365 days per year and insert the formula that uses Excel's date arithmetic (=Date( )) to
calculate the number of days from August 29, 2016 to Feb 24, 2017 (count one of these two dates in your formula
but NOT both). Display four decimals for all data except dollar figures.
James also wanted a specific "Output" section with the following descriptions: d1; d2; N(d1); N(d2); and Call Price.
A nifty function that James had instructed Sarah to use when finding the normal distribution for d1 and d2 was to
use =NORMSDIST function in Excel.
Sarah realized the same output section would need to be calculated for his put price as well.

Following James' instructions, produce an Excel sheet with the specific descriptions of the Input and
Output sections for both call and put option prices.

Provide a brief analysis of what the delta is for a portfolio of 1,000 Steel Inc. call options.

In the event that Steel Inc.'s share price declines by $1, how would Sarah make this portfolio risk free?

2.4
v.

REGULATORY RISK: FRTB IMPACT ON RISK MANAGEMENT (30%)

Ahmad, a senior analyst on the Project team, is working on a new regulation published this year called the
"Fundamental Review of the Trading Book" (Appendix C FRTB explained). To prepare for the implementation of
FRTB to the metals business, he assesses the sensitivity of Brexit to a portfolio of gold and silver. He uses data
during the month of June 2016 to investigate further, where values are in thousands (000s) and in CAD equivalent:

Date
6/1/2016
6/2/2016
6/3/2016
6/6/2016
6/7/2016
6/8/2016
6/9/2016
6/10/2016
6/13/2016
6/14/2016
6/15/2016
6/16/2016
6/17/2016
6/20/2016
6/21/2016
6/22/2016
6/23/2016
6/24/2016
6/27/2016
6/28/2016
6/29/2016
6/30/2016

Portfolio 1: XAG
Risk
VaR 99%
(Theoretical)
-981
-398
-1,095
-402
-414
-218
-306
-169
-765
61
-567
-215
-33
-65
-639
-234
-744
-273
-1,891
-767
-1,617
-593
-1,689
-619
-1,269
-465
-1,101
-404
-525
214
-153
112
-228
104
-654
-240
-900
-330
-423
-255
-378
-279
-1,552
-802

Risk
(Hypothetical)
-324
-365
-177
-102
55
-189
-11
-213
-248
-697
-539
-563
-423
-367
175
51
76
-218
-300
-141
-126
-1,184

Portfolio 2: XAU
Risk
VaR 99% (Theoretical)
-1,597
532
-320
107
-1,462
487
-901
300
-459
153
-317
106
-1,878
626
-875
292
-274
91
-2,261
754
-290
97
-87
29
-1,787
596
-343
114
-410
-137
-630
-210
-1,080
-360
-630
210
-1,080
360
-1,482
494
-1,360
453
-1,983
661

Risk
(Hypothetical)
484
97
534
273
139
96
569
265
83
867
88
55
396
104
-8,306
-1,365
-1,430
503
82
449
503
601

Given the above two portfolios, calculate "Unexplained" P&L and compute Mean and Variance ratios as
defined in Appendix C. Do these portfolios pass or fail P&L attribution and back-testing requirements for
FRTB?

Explain if there are any back-test breaches. Is there a correlation between your results and Brexit/gold/silver
prices? You can use gold and silver price charts and/or diagrams to explain your answer.

How can you tell if this portfolio is hedged?

Consider the effects of such breaches on the Bank. How could you correct the model to better predict such
breaches?

The Bank's risk-theoretical P&L is based on these risk factors: CM (commodity), FX (foreign exchange), EQ
(equity) and SP (credit spreads). Is the model missing any other risk factor?

FRTB requires banks to switch from a VaR model to an Expected Shortfall (ES) model; however banks still need to
calculate VaR at 97.5% and 99% confidence intervals.

Why have regulators asked banks to switch from a VaR to ES model? Please list the advantages for such a
change.

Why are banks still required to calculate VaR in addition to ES? Is there anything that ES fails to measure?

10

Appendices

3.1

APPENDIX A: OVERVIEW OF THE METALS BUSINESS*

Commodities play an important role in our daily lives and economic development. Not only are commodities used in
electronics, automobiles, farming, medicine, but also for hedging and investing. Commodities can be grouped into two
categories: soft commodities (corn, wheat, sugar, cocoa, orange juice) and hard commodities (oil, gas, gold, aluminum).
For this case our focus is the metals commodity industry which is part of the metals desk business strategy.
The metals business is a growing sales and trading business within TD Securities with trading operations based in
London, New York and Singapore. The desk consists of the precious metals (gold, silver, platinum and palladium) and
base metals (aluminum, copper, nickel, lead, tin and zinc) markets.
The metals desk acts as a market maker and principal to corporate and institutional clients. The clients include central
banks, financial intuitions, investors/fund managers, mining, refiners, retail, automobile, energy and chemical plants. The
desk provides products such as futures, forwards, swaps (physical and financial), options, spot, physical metal at various
locations, leasing (for precious metals) as well as foreign exchange and interest rate derivatives.
The desk provides buy and sell quotes to their clients and as such, effectively maintaining their inventory level to meet
clients demand and minimizing storage costs are imperative. The desk also must manage the risks of their positions,
and therefore understanding industry dynamics, market complexity, geopolitical and regulatory environment are
essential. The overall risks of the metals business must be consistent with TD's Risk Appetite.
*Hypothetical TD Securities desk strategy

3.2

APPENDIX B: MARKET RISK COMMENTARY EXAMPLE

US retail sales and inflation metrics were down for the day. Surprisingly, this did not impact the US Dollar Index (DXY),
which closed unchanged. This also had little impact on precious metals. The most recent U.S. Commodity Futures
Trading Commission reports highlighted that gold longs only cut 13.9k lots. Consumers are still backing gold performance
even in the face of even lower global bond yields.
On the other hand, base metals were not trading as much in volume. Most movement was occurring from lead and zinc
on weak iron ore performance in Asia. Nickel saw some rally around $100, which could be speculated on headlines from
ABC Holdings indicating that nickel mining units are laying off hundreds of workers.

3.3

APPENDIX C: INTRODUCTION TO FRTB

Earlier this year, the Basel Committee on Banking Supervision (BCBS) published revised standards for minimum capital
requirements for market risk called Fundamental Review of the Trading Book (FRTB). The FRTB demands a careful
read because the changes required are in the name fundamental.
A Capital Requirement is the standardized requirement in place for banks and other depository institutions that
determines how much liquidity is required to be held for a certain level of assets. These requirements are set to ensure
that banks and depository institutions are not holding investments that increase the risk of default. They also ensure that
banks and depository institutions have enough capital to sustain operating losses while still honoring withdrawals.
There are many moving parts in FRTB to calculate capital under revised standards, but in essence the FRTB requires
banks to change the calibration methods for risk models, replace Value at Risk (VaR) with an expected shortfall (ES) for
internal models, incorporate liquidity horizons into market risk, and make considerations around hedging. If banks are
able to prove the value of their internal models by showing one year of clean data through different measures / tests
given in FRTB rules, they will be allowed to use the Internal Model Approach (IMA) for capital charge calculation. Those
that generate inaccurate results will face harsher penalties than the old system and be forced back to the Standardized
Approach for a minimum of 12 months.

11

For Desks that the bank has deemed to be in-scope for the IMA, model approval is required. Each trading desk must
satisfy P&L attribution and back testing requirements on an ongoing basis. This is how it works:
The P&L Attribution assessment is designed to identify whether a banks trading desk risk management model includes
a sufficient number of risk factors that drive the trading desks daily P&L. The risk factors for that portfolio that are included
in the desks risk management model must be used to calculate a risk-theoretical P&L. This risk-theoretical P&L is
the P&L that would be produced by the banks pricing models for the desk if they only included the risk factors used in
the risk management model.
This risk-theoretical P&L would be compared to the hypothetical daily desk-level P&L, based on the mark-to-market value
of the trading desks instruments derived from the banks pricing models including all risk factors.
This comparison between the risk-theoretical and hypothetical P&L is performed to determine whether the risk factors
included in the desks risk management model capture the material drivers of the banks P&L derived from the banks
pricing models; and determine if there is a significant degree of association between the two P&L measures observed
over a suitable time period. The rationale for this assessment is that a desks risk management model should provide a
reasonably accurate assessment of the risks of a trading desk to be deemed eligible for the IMA.
The P&L attribution requirements are based on two metrics:
1.

Mean Test: The mean of the difference between the risk-theoretical and hypothetical P&L (unexplained P&L) divided
by the standard deviation of the hypothetical P&L; and

2.

Variance Test: The variance of the unexplained P&L divided by the variance of the hypothetical P&L.

If the first ratio is outside of the range of -10% to +10% or if the second ratio were in excess of 20%, then
the desk experiences a breach. If the desk experiences four or more breaches within the prior 12 months
then it must be capitalized under the standardized approach.

Back testing requirements are based on comparing each desks 1-day static Value-at-Risk measure to P&L at both
the 97.5th percentile and the 99th percentile, using at least one year of current observations of the desks one-day P&L.
If any given desk experiences either more than 12 exceptions at the 99th percentile or 30 exceptions at the 97.5th
percentile in the most recent 12-month period, all of its positions must be capitalized using the standardized approach.
Positions must continue to be capitalized using the standardized method until the desk no longer exceeds the above
thresholds over the prior 12 months.
Original paper: "Minimum capital requirements for market risk": http://www.bis.org/bcbs/publ/d352.pdf