Objectives

It is the responsibility of the risk control functions within a firm to ensure that
positions are prudently marked to fair valuation on the books and records and that
the risks are properly calculated and reported. Both the calculation of the PnL and
the risks for the positions of the firm are typically generated on the same end of day
positions.
1 The fair valuation of products is the easier of the two to digest and see the impact.
The valuations of the positions are marked to the prudent market value that is
represented both in the financial statements and in the management reporting
process. This is a fairly straightforward concept to visualize when considering
liquid exchange traded products. Pick up the newspaper, see the valuation and
make sure the end of day position is marked to it. The challenges of implementing
this are not difficult to visualize. However, the concept becomes challenging when
one considers simultaneously testing a series of global portfolios composed of
liquid and illiquid exchange traded and OTC products.

2 The fair valuation risks related to positions are represented in terms of sensitivities
(‘Greeks’). These risk sensitivity positions are based on system-generated calculations
that are less transparent. To the end user these calculations are generally
less intuitive and less transparent. These calculations are sometimes assumed to
be black box processes that are not easily understood. With a bit of effort, this
presumption is not quite true.
Defining objectives, measuring performance and determining what is need to
achieve objectives are all part of managing a process. The price testing objective sets
out the framework in which to operate and to judge performance. The objective
should include:
Ω Timing of positions to be tested
Ω Minimum frequency
Ω Goals on coverage
Ω Timeliness of reporting
Ω Self-assessment of price testing performance
An example of a price testing objective
We have established an objective of performing price testing the portfolios to end of
day marks at least twice a month, at the each month end and around the middle of
the month. Our goal is to test 100 per cent of the population for month end with
vigour and have the results summarized and reported within 5 business day of the
test date. Self-assessment will identify, document and address issues.