Capital Markets Examiner School, Providence, RI

Risk Management Questions

 Is the use of derivatives increasing or decreasing the risk profile?  Does the bank perform pro forma simulations to estimate the potential impact of the derivatives?  Does the bank reevaluate the effectiveness of the hedge after changes in interest rates?  Are the derivatives included in model simulations?  Does the bank understand and monitor counterparty risk?  Does the bank employ adequate personnel with the expertise required?  Does internal audit cover the derivatives function of the bank?

Balance Sheet Hedging Policies Documentation

The bank should maintain separate files for each derivative contract with the following information:  Executed ISDA agreement  Hedge description/objective (what is the bank hedging)  Hedge designation (cash flow or fair value)  Summary of the transaction (this information is also in the ISDA agreement)  Notional Amount  Fixed Rate  Variable Rate and corresponding index  Maturity Date  Fair value measurements (at least quarterly and preferably by a third party)  Effectiveness testing (at least quarterly)