June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 63 of 92 6.3. Elements of the Framework In order to determine what impact earnings will have on equity available to fund capital requirements, it is essential to have as part of the process the following elements: • Exposure Mapping: Exposure mapping is establishing a relationship between the Market risk factors and the components that comprise the earnings. It is a twofold process that a) establishes what Market risk factor is related to what earnings component, and b) establishes how they are related. • Scenario Generation: In this element, the range of potential values for the Market Risk factors is assessed. This can be done through Monte Carlo methods or closed form solutions however, the Market risk factor propagation process, based on the relationship established in Exposure Mapping, will drive the value of the components that make up earnings. This process will result in a “Distribution” of potential earnings over a given time frame. 6.4. Exposure Mapping During the Exposure Mapping exercise there are three primary aspects that should be determined 1. Identify all market risks that affect earnings 2. Determine market risk factor volatilities and define how the market risk factors are related to each other (correlations) 3. Define how market risks relate to earnings components 6.4.1. Identify all Market Risks As stated earlier in this chapter, the primary market risk factors that will affect most companies are • Commodity Prices • Interest Rates • Foreign Exchange Rates • Inflation Rates